Unsecured Car Loans vs Secured Car Loans

Car buyers with good credit can get unsecured car loans to pay for their vehicles. Unfortunately, many people don't qualify for unsecured loans because of bumps and bruises on their credit report. Secured car loans might be the best bet for these buyers. Let's explore the differences between these loans to find the one that best suits your needs.

Unsecured Car Loans

An unsecured car loan does not require the borrower to put up property as collateral. This is good news for the borrower; if they're suddenly unable to make their loan payments, they can at least rest assured that their other property won't be seized. But unsecured loans are risky propositions for lenders. That's why unsecured loans have more stringent approval criteria than secured loans.

You might be a good candidate for an unsecured car loan if:

  • You have steady employment.
  • You don't carry much debt.
  • Your credit score is 700 or higher.
  • You can afford a substantial down payment.
  • You don't want to risk losing your home or other property if you default on the loan.

When you apply for an unsecured car loan, you are asking the lender to put a lot of trust in your ability to repay the loan. This leads to a rather involved approval process. Lenders will first ask about your financial and employment status. They will be hesitant to offer you a loan if you have a high debt-to-income ratio. Most lenders prefer borrowers who spend less than 30% of their monthly income on existing debt.

If you do have the means to repay the loan, the lender will then pull a copy of your credit report. What they find there will determine whether or not you will be approved for an unsecured loan. Borrowers with a credit score above 700 and no history of repossessions will have the best chance of obtaining a loan. Because of the risk involved, unsecured loans typically have higher interest rates than secured loans. A good credit score will get you the best interest rate available. If the car dealership will not offer you a rate that's reasonable for your credit score, look for financing through your bank or another third-party lender.

Secured Car Loans

Of course, sub-prime borrowers need vehicles, too. If your credit score is 620 or below, or if you have a significant amount of existing debt, a secured car loan could be your best option.

You might be a good candidate for a secured car loan if:

  • You have a poor credit rating.
  • You have limited or no established credit history.
  • You do not have steady employment, or are self-employed.
  • You have property which can be used as collateral.

When you take out a secured car loan, you put up other property as collateral. Some people offer up their homes, boats, RVs, or other valuable properties. The collateral could even be the car itself. This is helpful for borrowers with bad credit; they can qualify for a secured loan when other types of loans may be off limits. But it also creates a liability if the borrower isn't able to repay their secured car loan. Any property they used for collateral can be seized by the lender to pay off the outstanding balance.

Which Car Loan is Right for You?

Your credit score, job history, and financial situation dictate the type of loan that best suits your needs. If you've worked for the same employer for at least two years, have little or no debt, and your credit score is 700 or above, you will likely qualify for an unsecured car loan. Most lenders will consider you a low-risk borrower, and you will get a good interest rate.

Not everyone falls under the category of traditional employment. What if you're self-employed? What if you changed jobs in the past two years? In those cases, your employment history might not stand up to the intense scrutiny that unsecured loans require. You could look for a co-signer for your next vehicle purchase, or you could apply for a secured auto loan.

A secured loan is also appropriate for borrowers who have suffered credit setbacks like bankruptcies or repossessions. New car buyers with no credit can also take advantage of secured loans. If they lack collateral, they can agree to let the lender repossess the vehicle if the loan isn't repaid.

The Bottom Line

Car loans are like credit cards; some are suitable for prime borrowers, and others are tailor-made for borrowers with poor or no credit. If you have a poor credit rating, you will not get the same terms as someone with a 700+. Still, you shouldn't give up your dream of owning a vehicle just because of your sub-par credit. Speak with your local dealership or go online to compare rates on secured and unsecured car loans.

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