Images by GettyImages; Illustration by Hunter Newton/Bankrate
Key takeaways
- A car can be used as collateral for a loan even if your credit score is low.
- Loans secured by your auto may come with lower rates than unsecured lenders offer.
- Car title loans are typically smaller with higher interest rates and shorter repayment terms than auto equity loans.
- You put your car at risk of repossession with both loan types, so consider the pros and cons carefully.
If you need extra cash and own a car with a lot of equity, you can use the car as collateral for a new loan. The annual percentage rates are usually lower than unsecured loan options.
If you have not-so-great credit, it may be a good alternative to an unsecured personal loan. Lenders may be willing to take a risk on bad credit borrowers knowing they have your car as collateral.
The most common types of secured are auto equity and car title loans. Both allow you to borrow money based on a percentage of the value of your car. Understanding how these loans work can help you decide whether a loan on your car is worth it.
Pros and cons of using a car as collateral for a personal loan
When you offer your car as collateral for a loan, you take some of the focus off your personal financial profile. Lenders are more concerned about how much they can sell your car for if you don’t repay the loan. However, there are some distinct disadvantages of borrowing against your car that you should know before you apply.
Pros
- Easier to qualify for. You’ll have a better shot at approval even if you have bad credit since the lender can take your car if you can’t repay your loan.
- Lower rates. Lenders base their rates on how likely you are to repay your loan and how much they can recoup if you default. Since they can recoup their losses by repossessing your car, you’ll typically get a lower rate using it as collateral.
- Faster approvals. Some auto equity and auto title lenders don’t even require your credit score to qualify, which could lead to funding the same day you apply.
Cons
- Car could be repossessed. If your car is your only source of transportation, losing it could wreak havoc on your life. Your credit will also be severely damaged if it shows that your car was repossessed.
- Higher rates than other auto refinance loans. You’ll pay a higher APR than a regular auto refinance loan since you’re increasing the amount that’s secured by your car.
- The car must meet lender requirements. Not all vehicles are eligible for financing because of factors ranging from age and mileage to overall condition.
- You could end up with negative equity. Car values drop with time, and the more financing you have, the more likely you are to end up upside down. That means your car would be less than the loan balance, making it hard to sell or trade in for a new car.
Types of loans with your car as collateral
Auto equity and car title loans are two types of bad credit personal loans requiring the use of your car as collateral. They are often considered decent emergency loan options because of their fast funding timelines. Each has different approval requirements and repayment terms you should consider before choosing one or the other.
Car title loans
A car title loan is also known as a “pink slip loan” or “title pawn” loan. With this type of loan, you receive a loan secured by the title to your car. The lender effectively owns a percentage of your vehicle until you repay the loan.
Loan amounts are typically small and only made on free-and-clear cars. You can typically only borrow between 25 and 50 percent of your car’s value. Interest rates are normally very high, and most require you to repay the balance in 15 to 30 days.
Auto equity loans
The biggest difference between auto equity loans and car title loans is you can borrow money even if you still owe on your current car loan. Your loan is based on the difference between what you owe and what your car is worth, known as your “equity.”
One significant benefit of auto equity loans over car title loans is that they often have lower interest rates and longer terms. However, it may not be easy to find a lender that offers these loans because not many banks or auto finance companies do.
Auto equity loan vs car title loan: Which is better?
If you’re unsure which type of loan to choose, compare their features side by side.
| An auto equity loan makes sense if: | A car title loan makes sense if: |
|---|---|
| – You still owe on your current car loan – You want lower rates at better terms – You have enough equity to qualify |
– Your car is free and clear – You only need a small loan amount – You can pay the loan off in 15 to 30 days |
What other collateral can you use for loans?
If your car doesn’t meet the requirements for an auto equity or car title loan, consider other secured loan options.
- Home equity loans and home equity lines of credit (HELOC). These loans allow you to convert a percentage of the equity you’ve built up in your home into borrowed cash. Most banks allow you to borrow the difference between what you owe and 85 percent of your home’s value.
- Share-secured loans or passbook loans. If you have a big chunk of money on deposit with your local bank, you may be able to get a loan secured by a portion of your deposited funds.
- 401k loan. If you’ve got a vested balance in your retirement account, you may be able to borrow against its value with a 401(k) loan.
- Business loan. You may be able to take out a business loan secured by inventory, equipment or the land and building you run your business from.
The bottom line
Borrowing against your car should always be a last resort. Before you use your car as collateral for a loan, see if a trusted friend or relative is willing to help out. Check your budget to see if you can save up the funds and pay cash instead of taking out a loan.
If a loan is the best — or only — option, shop rates and terms with a handful of lenders. Take extra time to compare each lender’s interest rates, repayment terms, and fees to get the best deal.
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