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Using a Car as Collateral for a Loan

By Janet Berry-Johnson
Data & Guides Cars Using a Car as Collateral for a Loan

When you need cash, a personal loan may allow you to borrow the money you need more affordably than tapping a credit card. However, if you’re having a hard time qualifying for a loan or finding a low interest rate, you may need to put up collateral.

If you own a car, you can use it as collateral for a loan, but there are a few things to know before doing so.

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Using a car as collateral for a loan

It is possible to use your car as collateral on a loan. This means you offer up the car as security so if you default on the loan, the lender can take the car to help compensate for its financial loss. 

To use your car as collateral, you must have equity in the vehicle. Equity is the difference between what the car is worth and what you owe on it. For example, if your car is worth $20,000 and you still owe $10,000 on your car loan, you have $10,000 of equity. 

This makes using your car as collateral tricky because cars tend to depreciate quickly. In fact, according to Edmunds [1] Edmunds. “Negative Equity is Surging During Coronavirus” - Accessed July 16, 2021 https://www.edmunds.com/industry/insights/negative-equity-is-surging-during-coronavirus.html%20, 44% of new car buyers are upside down on their car loan, meaning they owe more on the car than it’s worth. So, for example, if your car is worth $20,000 and the balance of your auto loan is $21,000, you have no equity in the car and won’t be able to use it as collateral.

Another complication is, according to Experian [2] Experian, “What Can Be Used as Collateral for a Personal Loan?” - Accessed July 16, 2021 https://www.experian.com/blogs/ask-experian/what-can-be-used-as-collateral-for-a-personal-loan/, “some lenders may not accept a car over five to seven years old as collateral.” So you may need to have a newer car with significant equity or even a clear title — meaning you don’t have an outstanding car loan — in order to qualify.

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How does using a car as collateral change the loan?

Loans with collateral are known as secured loans because the loan is secured by a specific asset (in this case, a car). There are several advantages to secured loans, including:

But it’s important to keep in mind that using your car as collateral for a personal loan puts your car at risk. If you run into financial problems and can’t make your loan payments, the lender can take your car. 

Types of loans you can apply for using a car as collateral

You have a couple of loan options when using your car as collateral.

Personal loans

A personal loan is a form of credit that you can use for virtually any purpose. For example, you can use a personal loan to consolidate other high-interest debts or make a big purchase. They typically have lower interest rates than credit cards.

Secured personal loans that use your car as collateral are also known as auto equity loans, and many lenders require you to own the car free and clear before using it as collateral. 

Car title loan

A car title loan is a secured loan that uses your car as collateral. According to the Federal Trade Commission [3] Federal Trade Commission, “What to Know About Payday and Car Title Loans” - Accessed July 17, 2021 https://www.consumer.ftc.gov/articles/what-know-about-payday-and-car-title-loans, you typically need to own the vehicle free and clear to get a car title loan. Lenders will usually allow you to borrow 25% to 50% of the car’s value, and you need to repay the loan in 15 to 30 days.

People may turn to car title loans when they need fast cash to cover an emergency bill or make rent, but this is an expensive option. Because of their high fees and short terms, the FTC says title loans usually have an average monthly finance fee of 25%, translating into an annual percentage rate (APR) of about 300%.

Cashback auto refinance

If you have an existing loan on your vehicle and need cash, you may consider a cashback auto refinancing loan. These loans refinance your existing car loan into a larger loan, giving you a portion of your equity back in cash.

Just keep in mind that a cashback auto refinancing loan adds to the amount of debt you currently have and may stretch your payments out over a longer term, which increases the likelihood of being underwater on your auto loan.

Other sources of collateral to consider

Collateral can be any asset you offer up as a way to qualify for a loan, as long as it has value and the lender is willing to accept it. Some options include:

Lenders who offer loans with cars as collateral

If you’re interested in using your car as collateral for a loan, you have a few options. Many large banks don’t offer auto equity loans, but several credit unions and online lenders do. 

You may also want to check with local banks and credit unions in your area to see if they offer personal loans using a car as collateral.

Alternatives to using your car as collateral for loan

Before using your car as collateral, it’s a good idea to consider alternatives. For example, can you find an affordable unsecured loan, borrow the money from a friend or family member, save up the money you need or find a way to earn more income? Any of these options may provide the funds you need without putting your transportation at risk.

If an auto equity loan is your best option, be sure to shop around. Rates and fees can vary greatly from lender to lender, so get several quotes to find the loan that’s right for you.

Sources

Janet Berry-Johnson

Janet Berry-Johnson is a Certified Public Accountant and freelance writer with a background in accounting and insurance. Her writing has appeared in Forbes, Freshbooks, The Penny Hoarder, and several other major outlets.

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