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How does collateral work for a car loan?
December 17, 2020●
4 minute read●
A car loan is a fundamental undertaking for any Aussie. The entire process is exhilarating, and at times even stressful. A lot of time and effort has to go into your research and selection before you can finally own a car. That said, you must go into the process with as much knowledge as possible. Collateral is a term that often appears in the financial lexicon, especially with regards to loans. In this post, we’ll be detailing what collateral truly means and how it affects your car loan. Before we get into that, let’s get familiar with the basics first.
What’s a car loan?
A car loan is a personal loan people take out specifically to purchase a vehicle. The vehicle could either be brand new or fairly used. The lender and borrower all agree on a stipulated amount of time, also known as the term, where the borrower gets what they call a principal amount. The person getting the loan agrees to pay back the term’s principal amount at an agreed interest rate. While there are typically two people involved, there might be a third party depending on the loan. Some people like to hire a broker that can act as a mediator between them and the lender. Simultaneously, others approach their banks to serve as the bridge between them and the financier.
Now that we’ve got the basics covered, we can move on to the article’s main point, collateral.
How does collateral come into a car loan?
Collateral is a kind of security you agree to put up until you can pay off your loan. It always has to be of equal or at least similar value to the loan you’re taking out. When you put something up as security, it means that should you default on your payments; the lender has the legal right to repossess the item. After repossession, the lender sells the property to recoup the defaulting debt. For car loans, the collateral is often the car. So many financiers would instead opt for that option because it is low-risk for them.
Is it applicable to all car loans?
No, collateral doesn’t have to apply to all car loans. We refer to it as a secured car loan, and when it isn’t, we call it an unsecured car loan. Secured loans are low-risk for lenders because they provide a kind of safety net if the borrower is suddenly unable to pay. As a result, their interest rates are also lower. It’s much easier to get these kinds of loans, especially if you have a bad credit rating and financiers have good reason to consider you untrustworthy. On rare occasions, the lender might request you to put up something else besides the vehicle. In such an instance, you can add valuable property such as your house to the agreement, but that rarely happens. The borrower signs a lien’s document, which the lender keeps and can use to repossess the items secured if the borrower breaches the agreement’s terms.
How to qualify for a secured car loan
A secured car loan is most comfortable to get, but specific requirements can make acquiring one a smoother process.
Credit rating: Generally, securing a loan is easier if you have a stable, and depending on the loan’s size, a sizeable source of income. But having money isn’t everything, you have to demonstrate that you’re reliable by showing proof of regular payments. Missing repayments, exceeding your credit card limit and declaring bankruptcy can lower your rating, making it hard to get a loan.
Employment: Being out of work is a red flag for most financiers because it signals that your income is unstable. Lenders aren’t too keen on giving out money to people who don’t show stable income prospects. Even when they can repossess the car, they would instead not go through that hassle. So self-employed individuals, and others, have to do a little extra to prove they can make meet their monthly payments.
Advantages of using collateral
More flexibility: There’s a safety net attached to using the car as collateral, so lenders are more willing to negotiate on their prices. It means with secured loans. You can save more money and enjoy more freedom till your debt is clear.
Lower interest rates: Once again, the provision of security ensures the lender isn’t stuck if you’re unable to pay. For that reason, secured car loans have considerably lower rates than their counterpart.
Lower requirements: Even without a clean credit score, you can still acquire a car loan using collateral. It could be the only option for people with unstable income sources or terrible credit scores.
Disadvantages of using collateral
You could lose your property: In the rare instance, when lenders request more than the vehicle as collateral, defaulting could be a devasting blow to your assets. If you miss any payments due to forces out of your control, you stand to lose more than the car.
That’s a wrap on collateral and how it works on car loans. Hopefully, you fully understand the term and the implications of choosing a secured car loan over an unsecured one and vice versa. So when making the decision consider your budget carefully and what you stand to lose in the worst-case scenario.
Written by Amelia Gomes