How does collateral work for car loans?

There are a number of ways you can pay for a new or used car, including taking out finance like a car loan. For some car loans, the use of collateral will be an important part of how the loan operates.

So what exactly is car loan collateral, and how does it work?

What is collateral and how does it work for a car loan?

Collateral is something valuable, like property, vehicles or other assets, that you agree to list as a security while repaying a loan on a new or used car. If you can’t pay the loan back in time or can’t make repayments you will generally have to surrender this secured item (or collateral) to the lender so they can sell it and recover the debt.

According to the Australian Government’s Moneysmart website, a lender can’t repossess or seize your collateral without a court order if you owe less than $10,000 or 25% of the total loan (whichever is lower). If you owe more than this and you are behind on your repayments, the lender can seize your collateral.

In order for this to happen, though, there are several requirements. The lender must send you (and your loan guarantor, if you have one) a notice giving you 30 days to pay the overdue amount. If those 30 days have passed without you paying the amount owed, or making arrangements to pay or asking to postpone the repossession, the repossession can then occur. The collateral used to secure most car loans is the car itself.

Is collateral used for all car loans?

Collateral is only used for secured car loans. It provides the lender with a safety net they can use to get their money back in the event you can’t repay the loan. This is what makes the loan secured. For unsecured loans, you don’t need to provide collateral as a security.

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Secured car loans

To get a secured car loan, you must agree to attach collateral as a security for the loan in case you fail to repay the money you have borrowed within the agreed timeframe. If the sale of your collateral does not cover the full amount you owe, you will have to pay what is left directly to the lender. Secured loans usually have a lower average interest rate because they carry less risk for the lender.

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What collateral could you use for a secured car loan?

Secured car loans will often use the car being purchased as the collateral. However, some other possible forms of car loan collateral could be other vehicles owned by the borrower, home equity, investment accounts, savings accounts or cash. Each form of security can carry its own set of advantages and risks, so it’s important to consider your personal circumstances before agreeing to provide any particular form of collateral.

Unsecured car loan

Unsecured car loans do not require any form of collateral. Instead, the lender will rely on your credit score to approve the loan. You can check your credit score for free with Canstar or via the Canstar app. Lenders’ use of credit history inquiries can make these loans a little more complex to apply for, especially for those with poor credit history. Unsecured loans also generally have higher interest rates than secured loans.

Loans with cars as collateral

When you take out a secured car loan to buy a vehicle, the car you’re purchasing is typically used as collateral. If you already own a car outright, however, you may also be able to use it as security to borrow money—a practice often referred to as a car title loan.

In this arrangement, your vehicle acts as a guarantee for the lender. You’ll need to hold a clear title, meaning the car isn’t still under finance. While the lender retains possession of the title, you usually get to keep driving the car during the loan term.

These loans are typically short-term and can be suited to individuals who need quick access to funds. For example, to cover an unexpected medical bill or pay for an emergency home repair. Because these loans are secured by your car, some lenders may be more willing to approve applications from borrowers with limited or poor credit, as the risk is lower.

Loans using cars as collateral are also sometimes called fast loans, as funds can typically be received within 24-48 hours of your vehicle’s assessment. As the loan is asset-backed, some lenders may consider your application despite a low credit score. You’ll still need to prove that you can repay the loan for your application to get approved.

Keep in mind that not all lenders in Australia may offer fast loans using cars as collateral. If you’re considering a loan with your car as collateral, it’s important to compare options and review the eligibility criteria carefully. There are also significant risks involved. If you default on repayments, the lender can repossess and sell your car to recover the outstanding amount, even if you’ve already made partial payments. You’ll also be responsible for any shortfall if the sale price does not cover the full debt.

As with any financial product, it’s important to weigh the pros and cons, understand the terms and conditions, and consider whether the loan suits your financial situation. Where possible, look at alternative finance options that might offer lower costs or less risk to your assets.

Who offers car loans?

Car loans may be offered by financial institutions such as banks or credit unions, peer-to-peer (P2P) lenders (as a personal loan), or directly through car dealers. You may also consider engaging the services of a car loan broker, if you want some guidance through this process.

Before you consider taking out a car loan, it’s important to research and compare the options available to you so you can make the right choice for your needs and budget. It’s important to read the Product Disclosure Statement (PDS), Target Market Determination (TMD) and other relevant documentation for each loan you’re considering to understand the benefits, risks and fees involved.

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