What is an unsecured car loan?
An unsecured car loan is one where you don't need to put up the car - or any other asset - as security on your loan. But there's a catch. Without that security, your loan options are more limited, and you'll likely have to pay a higher interest rate. Unsecured car loans are generally a less common car loan option in Australia.
How does an unsecured car loan differ from a secured loan?
Most car loans are secured loans, and the car you're buying is usually the asset used as security. As cars are expensive, car loans are generally for larger amounts, so many lenders will consider it risky to lend money without security as a backup.
With a secured car loan, if you were to default on your loan, the lender can repossess your car. Although you'll have a short window to fix the situation, the lender could sell your car to make up for its losses. This is why secured car loans usually come with lower interest rates as lenders have this security to fall back on.
Unsecured car loan types
There are two types of unsecured car loan interest rates: fixed rate or variable rate. With a fixed rate, you'll pay the same interest rate throughout the duration of your loan. This can be helpful to know exactly what your repayments will be each month, and how much you'll pay back overall. On the other hand, with a variable rate, your interest rate may go up or down. You can save money if interest rates go down, but you may end up paying more if interest rates go up. This can make it more difficult to budget.
How to compare unsecured car loans
When looking at your options, though they may be slim, there are still ways to compare and choose the unsecured car loan best suited to your circumstances. Here are a few considerations:
Interest rates
The interest rate, as well as the type of rate (fixed or variable) should be a major consideration. With an unsecured loan, finding a competitive rate can be reliant on how good your credit score is, how much you are looking to borrow, and the lender so it's important to shop around.
Comparison rates
In addition to interest rates, comparison rates should also be carefully considered. The comparison rate reflects the interest rate plus other fees and charges associated with the loan so that you can get a better idea of how much you'll end up paying overall. Trying to get the advertised interest rate as close as possible to the comparison rate is a good rule of thumb. Sometimes it may be worth opting for a slightly higher interest rate loan if it comes without a plethora of fees and charges attached. It can pay to do the sums.
Loan term
Generally speaking, the longer the loan term, the lower the monthly repayments. While this can suit some borrowers, lower repayments over a longer time can also mean you'll end up paying considerably more in interest. If you want to save as much interest as you can, a short-term unsecured car loan may suit your purposes. If you simply can't afford the higher monthly repayments, you'll need to find a longer-term agreement.
Repayments
You should also consider whether you'll be paying back your loan monthly or fortnightly as this can affect the interest you'll pay. Simply put, if you pay monthly, you'll make 12 repayments in a year. But if you pay fortnightly, you'll make 26, equating to 13 months in repayments. (The proviso here is in ensuring the fortnightly repayments are exactly half what the monthly repayments would have been - some lenders will calculate this differently.) Some car loans may also allow extra repayments, but these loans may incur extra fees upfront. Ensure you plan to make extra payments if you're paying extra to have the option.
Redraw facility
Some unsecured car loans may offer a redraw option that allows you to access any extra repayments you've made during the term of the loan. Again, this too can come at added cost, but it could be worth paying for it if you're planning to make good use of it. Paying extra on your loan can effectively reduce your interest costs while a redraw facility allows you access to those extra funds should you need them.
Pros and cons of unsecured car loans
If an unsecured car loan sounds like it's a good fit for you, let's discuss a few of the pros and cons so you can make the most informed decision.
Pros of unsecured car loans
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No asset as security: Your car is less likely to be seized if you default on your loan, which could be a good thing if you're buying the car as a gift for someone else. But this doesn't mean there are no consequences of defaulting on your car loan. Your credit score will take a hit, and you may face court proceedings which could result in a legal ruling requiring you to repay the debt (plus the lender's court costs) through other means, such as surrendering wages or forced sale of other assets.
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Lower interest rate than a personal loan: Though your interest rate will be higher than for a secured loan, unsecured car loans still generally have lower interest rates than unsecured personal loans.
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Borrowing flexibility: With an unsecured car loan, you can usually borrow as much as you'd like - as long as you can afford it. Because there's no car being used as security, there are no lender restrictions on what type of vehicle you can buy. It also means your loan could encompass any other car-related fees such as registration, insurance, etc.
Cons of unsecured car loans
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Higher interest rate than secured car loans: As we mentioned, since unsecured car loans are riskier, you will likely see this reflected in your interest rate. You'll be paying more interest on your loan than if you took out a secured car loan.
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Stricter eligibility criteria: Again, due to their higher risk, the eligibility criteria for unsecured car loans are usually much stricter and you will typically need a good credit score to get one.
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Potential legal action: If you default on your unsecured car loan, you won't lose your car, but you could face legal action. Your information could also be passed onto a debt collection agency, or your lender could file a civil lawsuit to get the money it's owed.
When an unsecured car loan might suit you?
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When you're buying a second-hand, older, or vintage car: You don't have to buy a brand-new car with a secured loan, but different lenders will have varying requirements. Some will draw the line for second-hand cars at two years old while others will allow up to 12 years. It means you shouldn't rule out a secured car loan for an older vehicle altogether, but an unsecured loan will come without restrictions on the age and type of car.
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When you need extra funds: As well as purchasing the car, an unsecured car loan will allow you to borrow the cost of any other additional expenses such as registration or the cost of vehicle modifications. Secured car loans will only allow you to borrow the value of the car.
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When you don't want to use your car as security: There are many reasons you may not want to risk losing your car if you default on your loan: it's vital to your livelihood, it's used by more people than just you, or you're emotionally attached to it. These are all reasons you may consider an unsecured car loan.
