If you have a personal loan, you may have heard that it is unsecured debt. Car loans, though, are different from personal loans in that the creditor uses the vehicle itself to secure the loan. Because the lender for your car loan uses the vehicle as collateral, it considers the debt a secured loan.
When you find a vehicle that you would like to finance, a number of lenders may offer to provide financing. Many dealers have their own finance departments, and banks and credit unions typically allow their customers to take out car loans. The lender may or may not require a down payment, but the lender will require you to sign documents allowing a lien on the vehicle. The lender allows you to take possession of the vehicle but, in most cases, the lender will retain the vehicle’s title until you pay the loan in full.
Because lenders use the financed vehicle to secure the loan, car loans are typically easier to obtain than credit cards or other unsecured debt, according to the automotive website Cars Direct. Borrowers with low income or damaged credit who cannot take out unsecured debt may be still be able to obtain a car loan; if you have a challenged credit history, these loans can help you rebuild a positive credit rating. In addition, lenders typically issue car loans with lower interest rates when compared with unsecured loans, and you may be able to pay back the loan over a longer period than the lender would allow on an unsecured loan.
Though secured car loans offer a number of benefits, you should keep a few considerations in mind when financing a vehicle. The lender will retain the title to the vehicle while you make payments on the car loan, so you may experience some hassles if you try to sell the vehicle to a private party before paying the loan in full. Also, the lender maintains a lien on the vehicle for the duration of the car loan, so the financial institution may exercise that lien and repossess the car if you fall behind in payments. Repossessions can have a significant impact on your credit score, and you may be unable to obtain unsecured or secured debt if the lender repossesses the vehicle. Finally, some lenders may request additional collateral or a co-signer if you have very limited or severely damaged credit.
Secured vs. Unsecured
Because the lender retains the title of the vehicle and maintains a lien, car loans are considered secured debt. By contrast, some borrowers may take out loans secured only by their promise to pay; these debts have no collateral and are known as unsecured loans. Examples of unsecured debt include personal loans and credit cards.
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