If you want to buy a car but don’t have enough money then you will need an auto/car loan to buy the car. A car loan is a very common type of loan that requires collateral. When you apply for a car loan, most lenders will insist on securing the loan with the vehicle itself. When you apply for a car loan you have to guarantee that you will pay back the loan in the agreed timeframe. Collateral is something that has monetary value and for a car loan, the vehicle provides security for the lender.
The main reason car loans are always secured with collateral is; cars are expensive assets and the loan amount is big compared to other loans. Moreover, cars don’t appreciate in value even though they do retain some worth. Therefore, because of the depreciating value, it is necessary for the lenders to have collateral to secure the car loan for the vehicle.
Jump To A Section
- 1 What Is Car Loan?
- 2 What Is Collateral?
- 3 Reasons Car Loans Are Always Secured With Collateral
- 4 Traditional Loans With Collateral
- 5 Advantages And Disadvantages Of Car Loan With Collateral
- 6 Requirements For A Car Loan With Collateral
- 7 Difference Between Secured Loan And Unsecured Loan
- 8 Which Loan Type Is Best – Secured Loan Or Unsecured Loan
- 9 FAQs About Why Are Car Loans Always Secured With Collateral?
What Is Car Loan?
A car loan is a type of loan that refers to various financial products that allow people to buy a car. Here, banks, credit unions, other financial service providers or lenders lend a sum of money to consumers so that they can purchase a car. Usually, people apply for a car loan when they don’t have enough money to pay for a new car. When you get a car loan, you agree to pay back the total amount along with the interest amount over a set period.
What Is Collateral?
When you are looking for a car loan or comparing a car loan, you might have heard the term “collateral car loan.” So, what does collateral means in a car loan? Well, in a car loan, collateral is something that you use to secure a loan with a lender; in this case, you have to use the vehicle/car that you will buy using the car loan. When you include collateral on a loan, the lender receives the right to seize that asset if you go into default. The most commonly accepted assets as collateral by the lenders are property, bonds, gold, savings certificates, deposits, vehicles, etc.
Reasons Car Loans Are Always Secured With Collateral
If you want to understand why are car loans secured with collateral then you have to put yourself in the lender’s place. Before lending money to someone, you would want to have proper security for your money. For a car loan, security is more important because cars are expensive. Therefore, to make the car loan less risky, the lenders always ask the borrower to secure the loan with collateral. For an auto loan, you can use your vehicle/car as auto loan collateral rather than your savings or house. Another key reasons for car loan collateral are because a vehicle’s value diminishes over time. Moreover, there is an everyday risk of driving and potentially damaging the car therefore lenders want security for the auto loans. If the borrower defaults on a car loan, then the lender will be able to repossess the vehicle and get some money back by selling it to others.
Traditional Loans With Collateral
A car loan is a very common type of collateral loan. Apart from the car loan, there are many other types of loans available that require collateral. For example, mortgage loans are secured by the home that is purchased using the mortgage loan. Similarly, a payday check is secured by a future paycheck. Other examples of secured loans are credit builder loans, life insurance loans, car title loans, etc. For a credit builder loan, you have to use a cash deposit as collateral.
Advantages And Disadvantages Of Car Loan With Collateral
Car loans with collateral are considered less risky for the lender. It means you can get approval for a higher amount of loan with a lower interest rate compared to loans without collateral. However, a car loan with collateral has advantages as well as disadvantages.
Advantages Of Car Loan With Collateral
1. Low-interest rates
2. Apply for higher amounts of loans and get approval
Disadvantages Of Car Loan With Collateral
1. This type of loan will put your car at risk in case you aren’t able to make payments
2. The lender will possess your car title so if you want to sell the car then you have to go through a few extra steps to complete the car selling process
Requirements For A Car Loan With Collateral
Providing the car as collateral is not enough to get approval for a car loan with collateral. There are quite a few requirements available that you have to meet in order to be approved for the car loan. Below are some common requirements that you have to fulfill –
Credit Score: You will need a good credit score to qualify for a collateral car loan. A credit score represents your creditworthiness and it is a very important factor that hugely impacts your interest rate.
Monthly Income And Debts: When you apply for a car loan, the lender will check your monthly income and other debts to make sure you can comfortably afford your auto loan payments along with your other financial commitments.
Employment: You must have steady employment for at least 12 months to qualify for an auto loan. Usually, the employment time frame varies depending on lenders.
Consistent Income: If you don’t have a job then you have to show a consistent income that will afford a car loan. Without a job or consistent income, you won’t be able to get a car loan with only collateral. Other forms of income accepted by lenders are alimony or disability payments, social security benefit payments, pension funds, retirement benefit payments, etc.
Residency Standards: If your credit score is poor then you have to fulfill certain residency requirements like living in the same home for the last 12 months, etc.
Difference Between Secured Loan And Unsecured Loan
|Characteristics of a Secured Loan||Characteristics of an Unsecured Loan|
|For borrower||Presence of collateral|
Typically, riskierMay require a down payment
May sell the property to repay the loan
Generally lower interest rates
Longer repayment period
Higher borrowing limits
Easier to obtain for those with poor or little credit history
|No collateral required|
Typically, less risky
Qualify based on credit and income
Stricter conditions to qualify
Generally higher interest rates
Lower borrowing limits
|For lender||Typically, less riskyThe lender can take your collateral|
The lender can hold the title to your property until the loan is repaid
A lender can’t take property right away if you default
Which Loan Type Is Best – Secured Loan Or Unsecured Loan
Both secured and unsecured loans have their advantages and disadvantages. Therefore, you have to pick a loan type that best suits your requirements. A secured loan will be best for you if you want to buy a large property or an expansive car. Here, you can use the property or car as collateral if you don’t already own other property which is very convenient. Moreover, secured loans are more accessible if you have a low credit score. You can also get a secure loan with a low-interest rate compared to an unsecured loan.
On the other hand, an unsecured loan will be best for you if you have an excellent credit score and stable income. If you have a high credit score then you can easily meet all the strict qualification criteria and get approval for the loan. Moreover, if you have a high credit score then you will be able to get a loan with a lower interest rate. So, both secure and unsecured loans are useful in different situations.
FAQs About Why Are Car Loans Always Secured With Collateral?
Are Car Loans Always Secured With Collateral?
A loan is secured when there is collateral. The most common secured loans are mortgage loans and car loans. These types of loans always have collateral therefore car loans are always secured with collateral.
Is Collateral Needed For A Car Loan?
Yes, collateral is needed for car loans. Most of the lenders want security for their money of car loans. Therefore, you have to include the car as collateral for a car loan.
Is It Easy To Get A Secured Car Loan?
Yes, secured car loans are much easier compared to unsecured car loans. If you have a good credit score and consistent income then you can easily get a secured car loan.
How Do I Know If My Auto Loan Is Secured?
If the auto loan lender retains the title of the vehicle and maintains a lien then your loan is secured. On the other hand, if your auto loan lender doesn’t retain the title of the vehicle and doesn’t maintain a lien then the auto loan is unsecured.
How Do Secured Car Loans Work?
The main purpose of a secured car loan is to buy a car. Here, you borrow an agreed amount of money to buy a car and then repay the loan amount with interest in equal payments. If you for any reason, fail to make your repayments on the loan then the lender will be able to legally repossess your car.
Magalie D. is a Diploma holder in Public Administration & Management from McGill University of Canada. She shares management tips here in MGTBlog when she has nothing to do and gets some free time after working in a multinational company at Toronto.