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If you need a personal loan but are having trouble finding a low rate or getting qualified, you may need to turn to secured loans. One option is to use your car as collateral. An auto equity loan allows you to borrow money against the value of your car.
While having a secured loan can mean a lower interest rate, consider the potential consequences before signing off on this type of financing.
Can I use my car as loan collateral?
Yes, you can use your car as collateral for a loan. Secured loans require an asset the lender can repossess should you fail to repay the loan. Collateral may help you qualify for a loan, particularly if you have bad credit. You assume more risk for the loan, so lenders may also offer lower rates in exchange.
You must have equity in a possession to use it as collateral on a secured loan. 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. The more equity you have in the loan, the lower your interest rate is likely to be.
The biggest risk of using your car as collateral for an auto equity loan is that if you default on the loan, your bank or lender can take possession of your vehicle to help repay your debt. Fees might also apply.
If you’re curious about using your car as collateral, check your lender’s terms to learn 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 lenders gain from collateral, secured 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 an appealing option, 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 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.
Auto equity loan vs. car title loan
A car title loan, also known as a “pink-slip loan” or “title pawn,” uses your car as the primary collateral for a loan.
Car title loans allow for borrowing anywhere from 25 percent to 50 percent of the value of your vehicle in exchange for turning the title to your vehicle over to the lender as collateral.
Car title loans are high-stakes because the loan term is typically very short — usually 15 to 30 days — and the interest rates are extremely high, around 300 percent APR.
These types of loans differ from auto equity loans in a few ways.
- A car title loan is a short-term loan compared to an auto equity loan, which usually comes with longer repayment terms.
- Car title loans are often much more expensive than auto equity loans.
- They typically allow people to borrow smaller amounts than auto equity loans.
- You typically cannot take out a car title loan if you owe money on your vehicle.
Due to the costly fees and interest rates, car title loans can go downhill very quickly if you cannot repay the debt in a short time frame.
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 personal loans that use your savings account as collateral. Banks and credit unions most often offer these.
The bottom line
Before using your car as collateral, double-check your other options. Do you have a trusted family relative 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 interest rates, repayment terms and associated fees to find the loan that’s the best fit.