If you need a personal loan but are having trouble finding a low rate or qualifying, you may need to turn to secured loans. One option is to use your car as collateral for a loan. But before you sign this type of financing, consider the potential consequences.
When is it a good idea to use my car as warranty?
It’s generally only a good idea to use your car as collateral if you’ve exhausted other traditional financing options and have a bad credit rating.
Can I use my car as collateral for a loan?
In short, it is possible to use your car as collateral for a loan. Secured loans require an asset that the lender can repossess if you don’t repay the loan. This can help you qualify for a loan, especially if you have bad credit. By putting collateral in place, you take on more risk for the loan, so lenders can also offer lower rates in exchange.
However, to use an item you own as collateral for 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 the resale value of your car 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 would 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 fail to repay the loan, your bank or lender may take possession of your vehicle to help pay off some or all of your debt. Charges may also apply.
If you’re curious about using your car as collateral, check your lender’s terms to see if they allow this type of collateral and how much equity you’ll need.
Benefits of using a car as collateral
There are two main advantages to getting a loan with your vehicle.
- Easier to qualify for a loan. Because of the extra security that lenders get from your vehicle as collateral, loans are generally much easier to obtain than traditional personal loans.
- Lower rates. Secured loans generally have lower interest rates.
Disadvantages of using a car as collateral
While using your car as collateral may be a good option for some, there are risks associated with this type of financing.
- More likely to become Upside down. There’s an added likelihood that you could be upside down – or have negative equity – because you’re adding more to the amount you already owe.
- Recovery potential. This is a big risk associated with using your vehicle as collateral. If you are unable to repay 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 warranties include:
- Your house. Home Equity Loans and home equity lines of credit (HELOC) use a percentage of the equity you have accumulated in your property as the loan amount or line of credit. Typically, banks allow qualified borrowers to tap up to 85% of the equity in their property.
- Your savings account. Share secured loans Where passbook loans are types of personal loans that use your savings account as collateral. These are most often offered by banks and credit unions.
- Title of your car. A car title loan, also known as a “pink slip loan” or “title pawn”, uses your car as the primary collateral for the loan. This is a high-stakes loan because it usually has very short tenors – usually 15 to 30 days – and charges extremely high interest rates. Due to high fees and interest rates, this loan option can go bad very quickly if you are unable to repay the debt in a short period of time.
The bottom line
Before using your car as collateral for a loan, check your other options. Do you have a trusted relative who is willing and able to offer a short-term loan? Do you have enough time to save for the expense or find extra income to cover it?
If a loan that uses your car as collateral is your best option, compare the prices with a handful of lenders. Compare repayment terms, interest rates and associated fees to find the loan that’s right for you.