Why Are Car Loans Always Secured With Collateral?

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 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.

Key Takeaways

• When you apply for a car loan, most lenders will insist on securing the loan with the vehicle itself
• For a car loan, in most cases, you have to secure the loan using the vehicle/car as a collateral
• When you include collateral on a loan, the lender receives the right to seize that asset if you go into default
• One of the main reasons for car loan collateral is, cars are very expensive, and their value diminishes over time
• With collateral, you can get a large car loan with a lower interest rate compared to loans without 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	Typically, riskier 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?

References:

1. https://businessfinancenews.com/loans/why-are-car-loans-always-secured-with-collateral/
2. https://www.carsdirect.com/auto-loans/secured-car-loan-requirements

Last Updated on November 1, 2022 by Magalie D.