Secured vs. Unsecured Car Loans: What's the Difference?

Learn the difference between secured vs. unsecured auto loans so that you can make the best choice for you from what's available.

Laura Leavitt | 

Mar 3, 2022 | 4 min read

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You'll typically encounter two specific types of car loans: secured and unsecured loans. Learning about these two types can help you get a big-picture understanding of how lenders take on risk — and why they might charge a higher interest rate on your car loan. Choosing between secured and unsecured auto loans comes down to weighing their benefits and drawbacks. Here, we'll explore the details of each so you can make the best decision.

Secured Vs. Unsecured Auto Loans: Definitions and Differences

The word "secured" in the context of loans typically means that if you do not make the required payments, the lender can take away an item of value. In the automotive lending world that's your vehicle. Most contracts state that missing even one payment can trigger the lender's ability to take the collateral — but in practice, many lenders give borrowers up to two or three payment cycles to get back on track before declaring a loan "in default." The item of value is typically called "collateral," and for car loans, it is typically the car itself.

Lenders prefer for you to make your payments because they may not be able to resell a car for as much as is owed on the loan. However, the ability to repossess the car helps them manage the risk of lending money to others. There are also big consequences for not making your payments — and as a result, secured loans often come with lower interest rates.

Unsecured loans, on the other hand, are loans that are made without collateral. If you fail to pay them, there would still be serious consequences for your credit score, and your debt could be sent to a debt collection agency — but the car wouldn't necessarily be repossessed. Because secured auto loans are the norm, you would most likely need to apply for a "personal loan" if you wanted to use an unsecured loan to buy a car: they are the most common form of unsecured lending.

Unsecured Loans Come With Some Freedoms

Unsecured loans provide a few freedoms that might be appealing to some buyers: the freedom to forgo comprehensive/collision insurance for your car or to buy from a private buyer with cash from your personal loan. The biggest benefit of the unsecured loan is that if you were to miss a payment or pay late, the lender has no claim to repossess your car as the collateral of the loan.

That being said, most people choose their loans with the expectation that they'll make the payments, and the lender has to offset this risk. If you choose an unsecured personal loan and pay for a car with it, you may get a much higher interest rate than on a secured auto loan. Higher unsecured interest rates aren't universal, but their lack of collateral does somewhat increase the lender's risk. Personal loans may be on a term as short as 12 months, which increases your monthly payment — and with larger monthly payments comes more disruption to the day-to-day cash flow of your household budget. Plus, a higher interest rate results in a larger expense to borrow money, raising the cost of your car overall.

Weighing the Trade-Offs of Secured and Unsecured Loans

The benefit of a secured auto loan is that, as long as you make your payments, you keep your car and can get a much lower interest rate. Lower interest means you pay less total for the car, and it can often result in a lower monthly payment.

If you are very worried about the potential for your car to be repossessed, you can still make an educated choice between your unsecured and secured loan options. It's usually a good idea to get loan quotes from multiple lenders. Evaluate your unsecured loan options knowing that, on average, these interest rates tend to be higher. Your secured loan options should be balanced with the potential for repossession, and you may want to make preparations so that repossession doesn't happen. However, you may be able to find a competitive rate on an unsecured loan and decide that it is the better route.

The takeaway? Most car loans are secured, but the possibility for an unsecured personal loan to pay for a car is out there. Saving a lot on interest and taking advantage of promotional financing can make secured loans a much better deal, saving you money over the life of the loan.

Laura Leavitt

I love a good spreadsheet and will happily calculate compound interest all day, but my biggest focus is helping people achieve their financial goals. That could be saving up for a dream car or calculating the right car payment for your budget so you can get a reliable daily driver. I research and write about personal finance so that making great financial choices becomes easier for us all.