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Traditionally, loans for big-ticket items — like homes and cars — use the item being purchased as collateral. If the consumer stops making payments, the lender can seize that collateral to cover the unpaid debt.
An unsecured auto loan — or a personal loan used to purchase a car — requires no collateral. Instead, if the borrower can’t pay, creditors can report the default to the credit bureaus and go to court to force collection since there is nothing to be repossessed.
How unsecured car loans work
An unsecured car loan is a personal loan used to purchase a new or used car. Since the loan is unsecured, the lender cannot repossess your car if you stop making payments. Instead, the lender can report the default to the credit bureaus and sue you.
On the downside, an unsecured loan’s interest rates and qualification standards are typically higher due to the lack of collateral.
Obtaining an unsecured car loan is similar to applying for a personal loan. You can begin by searching online for lenders who offer this type of loan and then visiting lenders’ websites to learn about the application process. Check your current bank and local credit unions to find out whether they offer unsecured loans.
Once you find a lender whose terms and interest rates work for you, submit your application and the required documentation.
Documentation generally includes information about your employment history, income, residence, debts and savings. As part of the application process, lenders will also pull your credit score. Most lenders have minimum score requirements. Lenders often reserve their best interest rates for credit scores from 720 up.
When you’re approved, the lender will usually send you the complete proceeds of the loan. You can then go to the car dealership or private vehicle seller as a cash buyer using the funds from your unsecured car loan.
Benefits of unsecured car loans
So why opt for an unsecured auto loan? Simplicity, says Kristin Shuff, LightStream’s senior vice president of marketing.
“One of the easiest ways to make that simple for people with excellent credit was for someone not to have to do title and extra paperwork, so they can be a cash buyer,” she says.
Buyers can get the money before they have even decided which car they want to buy, Shuff says. If they change their minds at the eleventh hour and decide on a different car or a different dealer, they don’t need the bank to cut another check.
“It really gives the client flexibility,” Shuff says. “If a consumer could get a better rate and less paperwork and more flexibility, that’s a win-win for them.”
While LightStream doesn’t need to know what kind of auto the borrower is purchasing ahead of time, it does reserve the right to request proof that the money was used to buy a car, she adds.
Where to get larger unsecured loans
Many lenders make five-figure unsecured loans to consumers who qualify. Check with a bank or credit union you currently do business with before moving on to compare other lenders.
For example, LightStream offers unsecured auto loans of $5,000 up to $100,000. For those with excellent credit who sign up for autopay, rates range from 5.73 percent to 19.99 percent as of October 2022. SunTrust Bank started making unsecured auto loans through its online arm, LightStream, in March of 2013, says Shuff. And PNC Bank makes unsecured loans of up to $35,000.
Typically, unsecured loans of this size should be reserved for cars you can’t finance with a secured loan. These can include collectibles and antiques.
Credit score requirements vary with the borrower, their circumstances and the loan, but applicants should have credit scores above 680, Shuff says. “The score is not as important to us,” she says. “We look at income and assets.”
Secured car loans are easier to get
Qualifying for an unsecured loan generally requires:
- A solid credit score
- A borrowing history that shows a track record of consistent, on-time payments
- A reliable source of income
Secured car loans require providing collateral to obtain approval. The lender keeps the car title until the loan is paid in full.
Banks generally offer better interest rates and more flexibility on qualification for secured loans because the car acts as collateral, says James Kendrick, vice president of accounting and capital policy for the Independent Community Bankers of America. The bank can more easily recoup its funds if the borrower defaults.
“It allows more buying power,” he says.
The bottom line
Using an unsecured personal loan can provide buyers who have excellent credit with flexibility during the car shopping process. If you change your mind about which car you want to buy, you won’t need to revise your application with the lender.
If you’re considering an unsecured loan, do your research first to learn more about the interest rates and terms associated with this type of borrowing.