If you need a personal loan but are having trouble either finding a low rate or getting qualified, you may need to turn to secured loans. One option is to use your car as collateral for a loan. But before signing off on this type of financing, consider the potential consequences.
Can I use my car as collateral for a loan?
In short, yes, it is possible to use your car as collateral for a loan. Secured loans require an asset that the lender can repossess should you fail to repay the loan. Doing so may help you qualify for a loan, particularly if you have bad credit. By putting up collateral, you assume more risk for the loan, so lenders may also offer lower rates in exchange.
However, to use an item you own as collateral on a secured loan, you must have equity in it. Equity is the difference between the value of the collateral and what you still owe on it. For example, if your car’s resale value is $6,000 but you still owe $2,500 on your car loan, you have $3,500 of equity in your vehicle. In this situation, you’d have positive equity, because your car is worth more than you owe on the loan.
The biggest risk of using your car as collateral is that if you default on the loan, your bank or lender can take possession of your vehicle to help pay for part or all your owed debt. Fees might also apply.
If you’re curious about using your car as collateral, check your lender’s terms to find out whether it allows this type of collateral and how much equity you’ll need.
Benefits of using a car as collateral
There are two main advantages to securing a loan with your vehicle.
- Easier to qualify for a loan. Due to the added security that lenders gain from your vehicle as collateral, loans are typically much easier to qualify for than traditional personal loans.
- Lower rates. Secured loans typically have lower interest rates available.
Drawbacks of using a car as collateral
Although using your car as collateral can be a good option for some, there are risks associated with this type of financing.
- More likely to become upside down. There is an added likelihood that you could become upside down — or have negative equity — because you are adding more to the amount that you already owe.
- Potential for repossession. This is a big risk that comes along with using your vehicle as collateral. If you default on your loan, the lender can repossess your car. Along with this, your credit score will be negatively impacted.
What other collateral can you use for loans?
Your car is not the only type of collateral you can use for loans. Other types of collateral include:
- Your home. Home equity loans and home equity lines of credit (HELOC) use a percentage of the equity you’ve accumulated in your property as a loan amount or line of credit. Typically, banks let qualified borrowers tap up to 85 percent of their home equity.
- Your savings account. Share secured loans or passbook loans are types of personal loans that use your savings account as collateral. These are most often offered by banks and credit unions.
- Your car title. A car title loan, also known as a “pink-slip loan” or “title pawn,” uses your car as the primary collateral for the loan. It’s a high-stakes loan since it usually has terms for a very short period — usually 15 to 30 days — and charges extremely high interest rates. Due to the costly fees and interest rates, this loan option can go downhill very quickly if you’re unable to repay the debt in the short time frame.
The bottom line
Before using your car as collateral on a loan, double-check your other options. Do you have a trusted family relative who is willing and able to offer a short-term loan? Do you have enough time to save up for the expense or find supplemental income to cover it?
If a loan that uses your car as collateral is your best option, shop around with a handful of lenders. Compare repayment terms, interest rates and associated fees to find the loan that’s the best fit.