One of the options available to individuals with poor or little credit is secured car loans. This loan is based on the value of collateral that is posted for the loan on the car.
Secured vs. Unsecured Loans
A secured loan is a loan that is taken with collateral offered in exchange for the loan. In many cases, the collateral is the actual item that the loan is being taken on. For example, collateral for a home loan is the home itself. If the borrower fails to meet the terms of the loan, then the home is placed in foreclosure and the mortgage lender takes possession of the home. The same is true for auto loans in many cases. The collateral for the loan is the vehicle that the loan is taken on. If the borrower fails to make the agreed-upon payments, the vehicle is then repossessed by the lender.
Unsecured loans on the other hand, are loans that are offered without any collateral offered in exchange. Examples of unsecured loans include most personal loans, student loans and credit cards. If the borrower fails to make the payments and meet the terms of the loan, the lender then has little recourse except to attempt to collect the loan through a collection agency or to sue for the balance owed to the lender by the borrower.
The Secured Loan Process
In some cases, a lender for an auto loan will ask for security beyond the vehicle itself. This may happen if a borrower has especially bad credit, no credit or has very low income.
If the lender asks for collateral as security, then it is up to the borrower to then offer their home, land, boat or other form of property to be held against the loan. This is usually taken in the form of a legal document called a lien. When the terms of the loan are completed then the lender releases the lien against the property.
If the borrower fails to make payments and meet the terms of the loan agreement, then the lender will have legal cause to begin to take possession of the property and exercise the lien.
Secured Loan Requirements
If a lender asks for collateral, the property offered must be owned by the borrower. However, in many cases, the collateral for a secured car loan is the car itself.
- Income. For every auto loan verifiable income is required. This can be in the form of paycheck stubs from your last several pay periods, copies of your federal tax returns if you are self employed or bank statements that show regular monthly deposits from other sources of income.
- Employment. You must be able to show a steady source of income. For most people this takes the form of employment. In general, lenders prefer that an applicant be able to demonstrate that they have steady employment for at least the last 12 months. However, for self employed individuals or people with other sources of income (spousal support, inheritance, etc) as long as you can demonstrate that your income is steady and predictable, most lenders will work with you.
- Residency. In many cases, lenders want applicants to demonstrate that they have steady residency and have been in their present home for at least 12 months. However, if you have recently moved into your current residence, you should be able to demonstrate that you have been in one home for at least 12 months in the past several years.
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Secured auto loans usually involve using the vehicle itself as collateral to secure the loan. Requirements for this type of loan are similar to almost any other kind of loan. Applicants must be able to demonstrate steady income, employment and residency.
Secured Car Loans Let You Pay Smaller Amounts over a Long Time
An unsecured auto loan is offered to you by the bank on the assumption that you are as good as your word and that you will pay the loan back on time, every month for the term. If you have a high FICO or credit score then you will easily qualify for this type of loan. However, the longest term available for this type of loan is generally 48 months and the rate is 12.9 percent.
Secured auto loans, where the auto serves as security, are generally running between 3 and 5 percent and they have been pushed out to a maximum of 72 months on average, and, in some cases, as far as 84 months (as of 2010). You can see that secured auto loans are, by far, the better choice for a car purchase than an unsecured loan. With interest rates at nearly 13 percent and a 4-year cap on the loan, you will find that buying a car with a personal loan will leave you with a far higher monthly payment than the standard car loan.
Advantages of Secured Car Loans
For those who own their homes or control other large assets, secured auto loans can be an option for getting the best interest rates and loan terms available from a lender. Aside from the liability of linking a property or asset to an auto loan, the secured auto loan offers specific and significant advantages.
- Looser terms. Because the lender has collateral to balance a loan against, those taking out secured auto loans can enjoy more flexibility in payment terms and other aspects of financing a vehicle. These more flexible terms can mean savings for the borrower as he or she can have better control over how the loan is paid back.
- Lower income requirements. Again, because the loan for an auto can be secured against collateral, a lender is generally not as hawkish about requiring a specific income level for a borrower to be eligible. That's why secured loans are great car loan options for potential buyers who may have significant freelance income or maturing investments, but not a steady paycheck that shows up well on paper.
- Tax-deductible income. Although the income on many kinds of personal loans is not tax-deductible according to the IRS, when a borrower uses a home for some types of secured auto loans, the interest may be tax-deductible. A home equity loan or home equity line of credit represents a type of loan where borrowers can deduct the interest on payments from their income taxes. However, borrowers should research whether these deductions can be applied above the standard deduction that many filers usually take.
- Lower interest rates. The search for low interest rates on an auto loan constitutes so much of the shopping process that is worth mentioning that those taking out secured auto loans can enjoy a much lower interest rates, again, based on the fact that the lender knows that collateral is available. While shopping, a potential car buyer should take a good look at all of the APRs, or annual percentage rates, offered by lenders to find the lowest ones that will not lead to the debt growing over time with a lot of compounded interest.
- Less hassle. Another thing about secured auto loans that are backed by collateral is that a lender may be less likely to order a repossession. That's because the auto being financed is not the primary asset tied to the loan.
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As long as a borrower is careful not to default on a secured auto loan, this type of financing for a vehicle can mean additional dollars in a buyer's wallet at the end of the loan term period. That's why, in times of skittish lenders and hard-to-get credit, many borrowers are going with secured loans for the necessary purchases that exceed their savings.
How to Research Secured Car Loans
If you're looking for secured car loans to buy your next car, you should know how to research the subject and be fully aware of the pros and cons before committing to the loan. Also known as car title loans, these auto loans can get you more favorable car loan options and car loan terms, but also carry a high risk factor. Before you decide on a secured car loan, use these steps to research the loans you've been offered.
- Check the penalties. Secured car loans mean that if you fail to make payments, your new car may be repossessed. Look at the specific terms included in your loan offer to see how many payments you would have to miss, as well as how high the penalty fees are, and don't get a secured car loan if your financial situation may cause you to lose your car. It will cost you money and harm your credit.
- Weigh the benefits. Since secured car loans are less risky to the lenders, they may offer some benefits that you wouldn't normally get with an unsecured loan. Browse your loan offers and look for low interest rates and extended repayment periods thanks to the loan being secured. Depending on your credit, you may be eligible for additional benefits such as no down payment requirement.
- Compare secured and unsecured loans. If your credit is good enough where you could get an unsecured loan, you'll need to compare the secured loan terms to those of an unsecured loan. Unsecured loans are less risky to you, and are generally the recommended choice if at all possible. By using these three steps to research secured car loans prior to buying, you'll be a better informed buyer and will be more likely to find the best loan deal for you.
How to Compare Secured Car Loans
If you've applied for some secured car loans or car title loans and received multiple approvals, you may wonder how to best compare the auto loans to find the car loan options and car loan terms that are most advantageous for you. Just like other car loans, the details of secured auto loans can vary widely depending on the lender offering the loan. These steps will help you compare the pros and cons of the loan offers you've been given to find the best options possible.
- Compare rates. The first and most obvious thing to compare among any loans is the interest rate being charged on the loan. Lower rates will cost you less money in interest. It's a good idea to convert the interest percentage to the number of dollars it will cost you over the loan term by using an online calculator; doing this will make overall comparisons easier.
- Compare penalties. With a secured car loan, it's important to find out what conditions will cause your car to be repossessed. Some lenders may have stricter conditions than others. Also check for extra fees and penalty fees that may end up costing you a lot of money.
- Compare benefits. Since secured car loans entail less risk on the part of the lender, you may be offered some benefits you normally wouldn't get with an unsecured loan. See if you've been offered such incentives as extended repayment periods by some lenders. You may be able to get the down payment requirement waived or other such benefits.
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By comparing the interest rate and the pros and cons of each secured car loan you've been offered, you can be sure to choose the most advantageous loan terms for your situation.
Home Equity Car Loans
One popular form of secured car loan is the home-equity line of credit or HELOC. There are several advantages to this kind of loan: often, the payment term is flexible, and the borrower can negotiate great interest rates by putting his or her home or other property up on the block to back up the deal. This means that in the case of nonpayment, the home can be vulnerable, but it also means much looser payment terms for someone who needs money for anything: for buying a car, doing renovations to a home or any other household cost.
When negotiating a home-equity loan or line of credit, watch out for excessive fees. Some lenders try to tack on extra charges, but the borrower already pays money to the lender in terms of interest. You'll also want to read the fine print to make sure that the payment terms and amounts are agreeable to your household budget.
Auto Pawn Loans
Another type of secured car loan is called an auto pawn loan or auto title loan. In these agreements, a driver simply provides a title to their owned vehicle as collateral for purchasing another car or truck. Unlike most conventional "pawn" situations, the driver can continue to use their owned vehicle as it is providing collateral. They don't have to take it to a "pawn shop" to be impounded. However, once again, if a borrower defaults on their payments, the vehicle they currently own and use can be taken away.
The thing to watch out for with these kinds of loans is what lenders call "rollovers." An initial auto upon loan can have a low interest rate, regardless of the driver's credit situation, but at the end of the loan term, if the vehicle is not paid off, the loan can "reset" with a higher interest rate. Some borrowers have seen multiple rollovers add up to 3-digit interest rates, which push interest through the roof and virtually guarantee a lifetime of debt. Some states are even taking action to limit auto pawn loan rollovers.
How to Get Secured Car Loans with Bad Credit
In order to get secured car loans, you have to have top of the line credit, but in most cases people don't. But don't despair, because there is always a way to get anything that you truly want. It is very important to try to keep a good credit history while you're young, since it may put a damper on your spending in later years. This means that you should always pay off those student loans on time and try to pay off your credit cards. In fact, while you're young and not working, try not to use credit cards at all when buying small items. To get secured car loans, you will need:
- People that you know. It is always good to have positive people around, who will say positive things about you. A good reference makes a great difference in securing bad credit car loans. The reference can come from an employer, friend or neighbor who has known you for a long time and can speak about your reliability. For car buyers who have never had a credit history or that have a bad credit history, it will go a long way to have someone who knows your character.
- Your house. If you own your home, this will be a great resource to use when trying to get a car loan. You can simply put your home up for collateral, but the only catch is that if you don't pay the loan back, the people that you have borrowed the money from can take your home. This is very risky, but if you are a reliable person with a job, you will be able to make the monthly payments.
- A vehicle of value. In most instances, you may also use the vehicle that you already have to get secured car loans. This may be an easier task than putting up your home. After all, it is less of a risk.
- Your job. Having a job can get you an unsecured car loan. If you are employed, you can put up the wages on your job as collateral. In the United States, your wages can be garnished for unpaid debts to companies. This means that when you are paid, your wages go directly to the place where you made the loan, if you fail to make proper payments. This may be the best possible solution for many people, if you have nothing of value and don't want to risk losing your home.
- Other possessions of value. You may in fact have other things around your home that you will be able to use as collateral, if you are trying to buy a vehicle with bad credit. Some people own items such as jewelry, boats, paintings and silverware. If they are worth something, you can use them to negotiate a loan.
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Disadvantages of Secured Car Loans
Potential car buyers who already have their own homes are often drawn to secured car loans for financing their new or used vehicles. Secured car loans provide some specific benefits for a borrower, but they also have distinct disadvantages. Here are some of the downsides of going with this type of loan.
- Putting your house on the line. A secured loan requires using a home or other property as collateral to secure lower interest rates or approval for those with less than stellar credit. Many homeowners are not happy with tying their home to an auto loan, especially in economic down times when a job can be lost any day, or an investment can vanish due to tighter markets.
- Long term loans tend to inflate. Another thing about a secured auto loan is that it can stretch over a long period of time. Since it is similar to any home equity loan, the loan period can be several years. The problem is that a driver may end up paying on an auto loan long after the vehicle in question has been retired.
- Extra charges can have a detrimental effect. With some types of secured car loans, it can seem like a lender is nickel-and-diming a borrower. The idea of a secured car loan is that a lender faces a lower risk. That should mean less income from the loan. However, lenders frequently like to sweeten the pot with up-front charges, opening charges, closing charges, valuation charges, and a lot more nonsense. If a borrower does not firmly remind the lender of terms of the deal, he or she could find that the loan is larded with a lot of extras that really mean a bad deal for the borrower.
- Danger in secured loans in conjunction with tight budgets. If a household budget is tight, the last thing that "heads of the house" want to do is to load down that budget with a monthly car loan. They may find themselves "borrowing" from the budget to pay the loan, or worse, from the loan to pay the budget. Any missed payments can mean the lender takes action on the home. That's not a great situation to be in.
These and other liabilities make a lot of potential car buyers think twice before taking on a secured auto loan, but in many cases, a moderated secure loan can be a great low interest way to finance a vehicle. In the end, buyers should just be careful to buy only what they can afford, and to reliably make their payments on time. With the right research and responsibility, the secured loan can be what it is meant to be: an easier loan process through using the home as convenient collateral.
When the lender takes away the car used as collateral, you will be offered the chance to prevent any action on the vehicle if you pay the back payments and any penalty fees the bank may add on. If you decide not to take this route, the bank will sell your car at auction and, hopefully, the auction proceeding will cover your debt. If it does not, then you must pay the difference, which can often be substantial.