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 vehicle may come with lower rates than unsecured lenders offer.
- Car title loans can be risky and 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 weigh 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 vehicle-secured loans 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 with bad credit, since the lender can repossess your car if you default on the loan.
- Lower rates: Lenders base their rates on how likely you are to repay the debt and the value of your vehicle. Since they can recoup their losses by repossessing your car, you’ll typically receive a lower rate when using it as collateral.
- Faster approvals: Some auto equity and auto title lenders don’t conduct credit checks, potentially expediting the approval process. This means you could receive same-day funding, which can be helpful in a pinch.
Cons
- Car could be repossessed: If you fall behind on payments, the lender can legally seize your collateral to repay the debt. If the car backing the loan is your only source of transportation, losing it could wreak havoc on your life. Your credit will also be severely damaged if your credit report reflects an auto repossession.
- Higher rates than 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 worth less than the loan balance, making it hard to sell or trade in for a new car.
Can I use my car as collateral if I still owe on it?
If you have enough equity in your vehicle to meet a lender’s requirements, you may still be able to use the vehicle as collateral even when you owe money on it. If your car is worth more money than the balance of the loan debt, you have equity in the vehicle that may serve as valuable collateral.
Types of loans that use your car as collateral
Auto equity and car title loans are two types of bad credit personal loans that use your car as collateral. Some personal loans can also be secured by a vehicle. These 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.
Secured personal loans
Best for: Low rates
A secured loan is a personal loan that requires collateral — in this case, a vehicle — in exchange for borrowing money. Because the loan is backed by collateral, it can be easier to qualify for this type of borrowing because the risk to the lender is reduced. Plus, that lower risk means lenders can extend a more competitive interest rate.
Many lenders offer vehicle-secured loans, but two of the best-known are Best Egg and Upgrade. To qualify for a secured personal loan, your vehicle may need to meet certain requirements. Best Egg, for instance, requires that vehicles have fewer than 250,000 miles and be a model year 1992 or newer. The vehicle must also have a clean title (no salvage or branded titles) and be owned outright with no outstanding lien.
Auto equity loans
Best for: Longer repayment terms
You can borrow an auto equity loan 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.” So, if your vehicle is worth $20,000 and you still owe $12,000, you have $8,000 in equity.
Auto equity loans often have lower interest rates and longer terms than car title loans. However, not many banks offer auto equity loans, so you may have a hard time finding this type of financing.
Car title loans
Best for: Smaller loan amounts
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 against vehicles that are paid off. 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. Car title loans are akin to payday loans in this way, making them an especially risky option.
What other loans are backed by collateral?
If your car doesn’t meet the requirements for an auto equity or car title loan and you don’t qualify for an unsecured 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 equity.
- Share-secured loans or passbook loans: If you have a big chunk of money on deposit with your local bank that you don’t want to touch, you may be able to get a loan secured by a portion of your deposited funds.
- 401(k) loan: If you have a vested balance in your retirement account, you may be able to borrow against its value. But keep in mind that if you lose your job or leave your employer, you may have to repay the loan in full or face early withdrawal penalties.
- Business loan: To finance small business needs, you can offer business inventory, equipment, assets or real estate as collateral.
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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