Why Are Car Loans Secured With Collateral?

Lauren WardUpdated February 10, 2023

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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.

A secured car loan is one of the most common types of loans that requires collateral. Financial companies may offer unsecured car loans, but lenders almost always insist on securing an auto loan with the vehicle itself.If you’re considering an auto loan, it’s important to understand how auto loan collateral works and why providing that collateral makes it so important to stay on top of your payments.

What Is Collateral for a Car Loan?

When learning auto loan terminology, you’ve probably heard of a collateral car loan. Collateral is any asset you use to secure a loan with a lender. When you use collateral on a loan, you give the lender the right to seize that asset in the event you go into default.What provides collateral to secure a car loan? The car itself is used as collateral in most cases. Other collateralized loans, such as home equity loans, can be used for the purpose of buying a new or used vehicle. The collateral for a home equity loan is the borrower’s home. There are different types of car loans, including unsecured auto loans that never require collateral for car loan financing.

Why Are Car Loans Always Secured with Collateral?

As mentioned above, lenders may offer unsecured car loans without collateral. In other words, car loans are not always secured with collateral. That being said, it’s highly common for banks, credit unions, and private lenders to offer secured auto loans in which the financed vehicle serves as collateral on the loan.A car is an expensive purchase. But, since public transportation is only widespread in large cities, it’s a purchase most adults may need to make. In order to make auto loans less risky for the lender, the would-be borrower in many cases would be required to secure the loan with collateral. Luckily, the car itself is typically used as auto loan collateral, rather than the borrower’s savings or house.Another reason why car loans are often secured with collateral is because a vehicle’s value typically experiences car depreciation over time. Paired with the everyday risk inherent in driving and potentially damaging the car, including collateral in an auto loan lowers the risk for the lender that it won’t be able to recoup its money in the case of a default.Why are car loans always secured with collateral? When a borrower gets behind on his or her payments and goes into default, the lender may repossess the car. It can then be resold to try and get back some of the losses experienced by the lender. This is why auto loan lenders usually — but not always — demand collateral for car loan financing.

Traditional Car Loans With Collateral

Here are examples of traditional car loans that may require collateral:

Simple interest auto loans issued by a private lender

Direct financing auto loans from a bank, credit union, or financial company

Indirect financing auto loans arranged by a car dealership

Consumers can go to a bank, credit union, or private lender requesting direct financing auto loans. Consumers can also go to a car dealership requesting indirect financing arranged by the dealer. These are the traditional ways of getting auto loan financing, and these loans are typically secured by the financed vehicle.The way how auto loans work is that lenders provide financing to help borrowers purchase a new or used vehicle. Borrowers are expected to repay the car loan over a set term, and these loans may include interest charges. What provides collateral to secure a car loan? As mentioned earlier, the car itself is used as collateral in most cases.Lenders may impose late fees if you fail to make a timely payment on your loan. But lenders may also honor a car payment grace period before such penalties would apply. Lenders may repossess the vehicle if borrowers become seriously delinquent on a secured car loan.Borrowers are expected to provide proof of identity and proof of income when applying for auto loan financing, among other car loan requirements.Recommended: Auto Loan Shopping Guide

5 Types of Collateral for a Car Loan

Below we highlight five car loan collateral examples:

1. A Different Car

A car owner may pledge their vehicle as collateral for a secured personal loan and use the secured loan to buy a second car. This is an example of car loan collateral where one vehicle serves as collateral to help the borrower secure financing to buy a second vehicle without selling the first vehicle.

2. The Car the Loan Applies to

When you buy a car with a secured auto loan, the financed vehicle itself typically serves as the collateral. This means lenders may repossess the financed vehicle if borrowers fail to repay the loan.

3. Stocks

Investors may borrow nonpurpose loans and use the proceeds to buy cars. A nonpurpose loan is an extension of credit in which borrowers pledge securities as collateral and use the funds for personal reasons other than buying, trading, or carrying margin stock.

4. Home Equity

Homeowners may borrow home equity loans and use the funds to buy a new or used car. You could lose your home to foreclosure if you default on a home equity loan or home equity line of credit.

5. Savings

Savings account holders may borrow against the cash value of their deposits. Credit unions, for example, may give their members the option to take out a savings secured loan. You can pledge your savings as collateral and use the loan proceeds to buy a new or used car.

Can You Get an Auto Loan With No Collateral?

Yes, it’s possible to get a car loan with no collateral. As mentioned earlier, lenders may offer unsecured auto loans that don’t require any collateral. The major benefit, of course, is that you protect your personal assets from being seized if you ever go into default (although this doesn’t get rid of your liability for the loan funds).A no collateral auto loan will typically come with higher interest rates. Rather than using the car as collateral, the lender charges more to help make up for potential losses in the future. It’s also important to remember that even if you don’t use your car as collateral, the lender can still take you to court if your loan goes into default. If you lose the case, the court may order wage garnishment to repay the debt. Lenders expect borrowers to repay their principal loan amount and any finance charges that may apply.

What Is an Unsecured Auto Loan?

An unsecured auto loan is a car financing contract that doesn’t include a security agreement. This means the borrower agrees to buy a car without pledging any assets as collateral. The borrower uses the unsecured auto loan to buy a new or used vehicle, and the lender has no right to seize the vehicle if the borrower defaults on the loan.Failing to repay an unsecured auto loan, however, can have severe consequences. Your credit score may plunge, and lenders may take you to court for breach of contract.Recommended: Paying the Principal on a Car Loan

Secured vs Unsecured Car Loans

The below table compares secured car loans vs. unsecured car loans:

Secured car loans	Unsecured car loans
The financed vehicle serves as collateral on the loan	The borrower receives auto loan financing without pledging any assets as collateral
The lender may repossess the vehicle if the borrower defaults on the loan	The lender may not seize the financed vehicle if the borrower defaults on the loan
The lender has a security interest in the vehicle	The auto loan contract features no security agreement

Requirements for a Secured Auto Loan

Even with a collateral car loan, you’ll need to meet the lender’s requirements in order to be approved. Typically, these might include some or all of the following:

Income

Your income may serve as an important consideration. The lender wants to make sure you can comfortably afford your auto loan payments in addition to your other financial commitments. Lenders may consider your annual income from all sources, including any income from salaries, wages, alimony, Social Security, and pension benefits.

Employment

Employment might be an important consideration, particularly if your main source of income comes from a salary or wages. You may need steady employment for at least 12 months to get a secured auto loan, although the exact time frame can vary from lender to lender.

Credit Score

This representation of your creditworthiness is based on your credit history as reported by a credit bureau and is a major factor and impacts your interest rate. Borrowers with bad credit may get approved for a car loan, but the interest charges could be particularly high.

Residency

If your credit is poor, a lender may set certain residency requirements, such as living in the same home for the last 12 months.

Using Your Car as Collateral for a Loan

If you’re a car owner, you may use your vehicle as collateral for the following loan products:

Secured personal loan
Car title loan
Auto equity loan

The Takeaway

Borrowing money to buy a car is a common transaction many consumers make. The financed vehicle usually serves as collateral on a car loan, and borrowers are expected to repay the loan in full over a set term. This includes loan principal and any interest charges you may owe.If you’re burdened with car loan debt and would like to explore your auto refinancing options, Lantern by SoFi can help. Refinancing might be right for you if you can lock in a lower interest rate. Explore your options and consider applying with a lender of your choice.

Frequently Asked Questions

What is collateral for a car loan?

What is a secured car loan?

What is an unsecured car loan?

What are the four types of collateral for auto loans?

How old can a car be to be used as collateral for a loan?

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About the Author

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.

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