What Type of Credit Is an Auto Loan?

Q: What type of credit is an auto loan?

Auto loans are a type of installment loan, meaning that you pay them in regular installments, typically monthly.

Q: Is an auto loan secured or unsecured?

An auto loan is usually a secured loan because the car acts as collateral for the loan. It is possible to buy a car with an unsecured loan, but because these loans are riskier for lenders, you may get a higher interest rate on an unsecured loan. You might also need a higher credit score in order to qualify for an unsecured loan.

Austin KilhamUpdated May 30, 2023

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When you take out an auto loan, you receive money to purchase a car, and you make regular monthly payments until the loan is paid off. These regular payments make auto loans a type of installment loan. Here’s everything you need to know about this auto loan type of credit, including how it may affect your credit score.

How Does Installment Credit Work?

What type of credit is a car loan? It’s an installment loan. When you take out an installment loan like an auto loan, you borrow a lump sum of money to buy a car. You repay what you borrowed on a regular schedule over a fixed period of time. In addition to paying back the loan principal (the amount you borrowed), you’ll also pay interest. How car loans work is that your lender will divide the principal and interest payments over the number of repayment periods (60 months, say) through a process known as amortization. The size of your monthly payments will depend on how much you borrow, what your interest rate is, and your loan term or length.As you pay back the installment loan for your car, each payment will first go toward paying off interest, and then to paying down your loan principal. Over time, as you continue to pay the loan, the principal balance will shrink and so, too, will the percentage of each payment that goes to interest.

Are Auto Loans Secured or Unsecured Credit?

Still wondering what type of credit is an auto loan and whether the loan is secured or unsecured? Although there are different types of auto loans, in general, auto loans are secured credit because your vehicle acts as collateral for the loan. If you fail to repay the loan, the lender can seize your vehicle to help recoup their money. Not all installment loans are secured. Personal loans, for example, tend to be unsecured, and require no collateral. However, unsecured loans are riskier for lenders. Because of this, and to help compensate for the risk, unsecured loans often come with higher interest rates.

Auto Loans and Your Credit Score

Your credit score represents your credit history and how responsible you’ve been with managing your debt in the past. An auto loan type of credit can have an effect on your score. Here’s a look at how car loans impact your credit score.

Can an Auto Loan Improve Your Credit Score?

An auto loan could strengthen your credit score, provided that you consistently make your car payments on time. The largest component of your credit score is your payment history. In fact, payment history makes up 35% of your FICO® score, which is the most common credit scoring methodology. If you miss payments for your auto loan, or your payments are late, your credit score will typically take a hit. Auto loans can affect your credit in other ways as well. For example, lenders like to see that you’re good at managing different kinds of debts, including credit cards and installment loans. This is known as your credit mix, and it makes up 10% of your FICO® score. Taking out an auto loan could add to your credit mix. Don’t be surprised if your credit score initially drops a few points when you sign up for an auto loan. This is likely the result of the hard credit inquiry (or credit check) that’s required when you apply for the loan. The new loan will also increase your debt load, which might have a slightly negative effect on your score. But these effects should be temporary once you make your first few car payments on time.

What Credit Score Do You Need for a Car Loan?

The credit score requirements for auto loans typically depend on the lender you’re using. Banks and credit unions tend to offer loans to borrowers with higher credit scores in the 601 to 850 range. Captive finance companies, which are companies that are affiliated with car manufacturers, may offer loans to those with lower scores as well as those with higher scores. Borrowers will typically need a credit score of 501 to 850. Car dealerships and independent finance companies may offer loans to borrowers with bad credit scores, as well as to those with higher scores. For these loans, you’ll need a credit score of 300 to 850. The car loan interest rate a lender will offer you is largely determined by your credit score. Borrowers with the highest scores are typically given the lowest rates. Borrowers with lower scores are seen as riskier by lenders and are offered higher interest rates, which increases the overall cost of borrowing. If you can’t find a reasonable interest rate, work on strengthening your credit score. Pay bills on time, pay down your debt, and correct any mistakes on your credit report. You can receive a free credit report from the major credit bureaus TransUnion, Equifax, and Experian, or from AnnualCreditReport.com. Report any mistakes you find to the credit bureaus immediately.

Refinancing Can Help Lower Rates

If you have an auto loan with a high interest rate, you may want to consider auto refinancing. This allows you to pay off your old loan with a new loan, ideally at a lower interest rate and better terms. You might want to refinance a car loan when interest rates drop or when your credit score has strengthened. It might also make sense to refinance to a loan with a lower interest rate early on, when more of your installment payments are going to interest. Later, when more of your payment is going toward paying down principal, refinancing may not offer as much potential savings. You can figure out how much refinancing might save you by using an auto loan refinance calculator.

The Takeaway

Auto loans are a type of installment loan that you pay back with regular monthly payments, including interest. The size of your payment will depend on the size of the loan you’re taking out, the interest rate, and the length of the loan. Your credit score can affect the interest rate you get.But you don’t have to live with that car loan. Refinancing could help adjust your payment by lowering your interest rate or offering you a better loan term. If you’re looking for auto refinancing options, you can compare rates and terms from multiple lenders all at once with Lantern to find the best loan for your situation. Prequalifying takes just minutes. Compare auto refinance rates with Lantern.