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Using a Car as Collateral for a Loan

By Michelle L. Black
Data & Guides Cars Using a Car as Collateral for a Loan

When you need to borrow money, having access to collateral can come in handy. Many people think of using their home equity as a way to qualify for affordable financing. But if the vehicle you drive is paid off or worth more than you owe on your current car loan, it may also be possible to use your car as collateral to secure a loan.

On a positive note, interest rates on auto equity loans are often lower compared to other types of credit. Yet that’s not always the case—especially when it comes to predatory auto equity financing options like car title loans. 

It’s also important to understand that with any type of car equity financing, there are risks. So, you’ll want to research how car equity financing works along with its pros and cons before you use your car as collateral for a loan. You should also know there are alternative ways to borrow money, especially if you feel uncomfortable using your car to secure a loan. And there are other types of collateral you can use to secure financing as well. 

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Can I use a car as collateral for a loan?

Using auto equity to get a loan isn’t the most common way to borrow money. But in many cases, it is possible to use a car as collateral for a loan.

Lenders call this type of credit a secured loan because you back the money you borrow with an asset—in this case, the equity in your vehicle. However, before you can use your car as collateral for a loan, you must have enough equity in your vehicle to satisfy a lender’s qualification requirements.

Equity is the difference between the value of your car and the amount of money you still owe to your auto lender. If you own a car outright, you have 100% equity in your vehicle. But if you still owe a balance on a car loan, your vehicle equity will be some lesser amount. [1] BestEgg.com. “What is Equity in a Car?” https://www.bestegg.com/blog/what-is-equity-in-a-car/

For example, imagine you have a $10,000 auto loan balance and your vehicle is worth $20,000. In this scenario, you have 50% or $10,000 worth of auto equity.

In some cases—especially at the beginning of your auto loan or with long-term auto loans—you might find yourself with minimal equity or negative equity (owing more than your car is worth). According to Edmunds, 24% of vehicle trade-ins in Q3 2024 had negative equity or were “underwater” on their auto loans. You wouldn’t be able to use your car as collateral for a loan in either of these situations. [2] Edmunds.com. “Negative Equity on the Rise: The Average Amount Owed on Upside-Down Car Loans Hit an All-Time High in Q3 2024, According to Edmunds.” https://www.edmunds.com/industry/press/negative-equity-on-the-rise-the-average-amount-owed-on-upside-down-car-loans-hit-an-all-time-high-in-q3-2024-according-to-edmunds.html#:~:text=Q3%202024%20data%20from%20Edmunds,and%2018.5%25%20in%20Q3%202023

Pledging your car equity as collateral to secure financing might help you qualify for a better loan offer because it reduces the risk for the lender. As a result, you may be able to borrow money at a lower interest rate and access higher loan amounts—often up to 100% of your auto equity and sometimes more.[3]

But there’s a trade-off to consider where auto equity loans are concerned. Although the lender’s risk is lower, as a borrower you have more to lose. If you default on the loan and don’t repay as promised, the lender typically has the right to repossess your car. So, you shouldn’t even think about applying for this type of loan unless you’re confident you can afford the monthly payments. [4] SoFi.com. “What Is an Auto Equity Loan?” https://www.sofi.com/learn/content/what-is-auto-equity-loan/

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Types of loans you can get using your car as collateral

If you want to use your car as collateral when you borrow money, the two most popular financing options are auto equity loans and car title loans. Yet although you can use car equity as collateral with both of these types of loans, these financing products feature major differences you should understand.

Auto equity loans

An auto equity loan is one type of secured loan you may be able to apply for using your car as collateral. With an auto equity loan, you don’t typically need to own your vehicle outright to be eligible for financing. But you do need enough equity in your vehicle to satisfy the lender. It can also be helpful to have a newer vehicle with lower mileage (e.g., models under seven to ten years old and with less than 150,000 miles) if you want a lender to approve you for this type of financing. However, keep in mind that every lender has its own loan qualification requirements. [5] Huntington.com. “Auto Loan Refinancing.” https://www.huntington.com/Personal/auto-loans-overview/auto-loan-refinancing

Of course, if you default on an auto equity loan the lender may be able to repossess your vehicle in an effort to recuperate its losses. But it’s important to point out that if you still owe an outstanding balance on an auto loan, the lender that holds the title to your car will be in the first lien position. That means if a repossession happens, the first lienholder (aka your primary auto lender) will typically collect the repayment of its debt first. [6] Investopedia.com. “Second-Lien Debt: Definition, Risks, Example.” https://www.investopedia.com/terms/s/secondliendebt.asp

With an auto equity loan, you may qualify for a lower interest rate compared to unsecured personal loans. Repayment terms may also span up to seven years or more with some lenders. [3] BestEgg.com. “Use your car as collateral to get cash fast.” https://www.bestegg.com/personal-loans/vehicle-equity/ Yet although your auto equity lowers the lender’s risk with this type of loan, lower interest rates and favorable repayment terms aren’t automatic. A lender will consider other factors when determining your loan eligibility and borrowing terms. So, it’s best to have a good credit score and a low debt-to-income (DTI) ratio if you want to improve your chances of qualifying for an attractive loan offer.

Car title loans

Car title loans represent another way to borrow money using your vehicle as collateral—even if you have bad credit or no credit. Yet this type of financing tends to be expensive and predatory. For that reason, they’re also illegal in many states (though some car title lenders find loopholes and still offer the loans as other types of financing to avoid state credit laws).

Title loans are similar to payday loans, sometimes featuring APRs as high as 300%. You can use these types of loans to borrow a small amount of money (often $100 to $10,000) for a short period of time. But you must typically own your car outright to take out a title loan. When you receive your loan proceeds, the lender will take your car title until you repay the money you borrowed plus your finance fee—and you’ll often have 30 days or less to do so. [7] Experian.com. “How Do Title Loans Work?” https://www.experian.com/blogs/ask-experian/how-do-title-loans-work/

If you’re unable to repay the loan as promised, the lender might let you roll over a car title loan for another 30 days (paying another finance fee and other potential fees in the process). But eventually, if you default on your debt you risk losing your vehicle to repossession. [8] Consumer.gov. “Car Title Loans Explained.” https://consumer.gov/cars/car-title-loans-explained

Due to the high cost of title loans combined with the short repayment schedule, it’s critical to avoid this type of financing. Car title loans are not only expensive, there’s a high chance you could lose your vehicle if you can’t afford to repay the loan on time. According to a 2016 study from the Consumer Financial Protection Bureau (CFPB), 20% of borrowers (one in five) who used single-payment car title loans lost their vehicles to their lender when they were unable to repay the debt. [9] Consumerfinance.gov. “CFPB Finds One-in-Five Auto Title Loan Borrowers Have Vehicle Seized for Failing to Repay Debt.” https://www.consumerfinance.gov/about-us/newsroom/cfpb-finds-one-five-auto-title-loan-borrowers-have-vehicle-seized-failing-repay-debt/

Pros and cons of using a car as collateral for a loan?

We’ve already covered the fact that you should avoid car title loans at all costs. But if you’re considering using your car as collateral for an auto equity loan, it’s a good idea to understand the key advantages and disadvantages of this type of credit as well.

Pros of auto equity loans

Cons of auto equity loans

Other types of collateral you can use for loans

Lenders typically don’t require collateral for personal loans. But there are some situations where you might want to apply for a secured loan in an effort to lock in a more attractive interest rate, better borrowing terms, or improve your chances of qualifying for credit.

If you’re unable to qualify for an auto equity loan or you’re uncomfortable putting up the equity in your car as collateral for financing, here are some other types of collateral lenders might be willing to accept instead.

Keep in mind that when you take out a secured loan, the lender will put a lien against the collateral you provide. When a lien is in place, the lender has the right to take possession of your collateral if you fail to repay your debt as promised. So, you should never pledge any asset as collateral that you’re not comfortable risking in this manner. And you should never take out any loan—especially a secured loan—unless you’re sure you can afford the monthly payments. [11] Experian.com. “What Can Be Used as Collateral for a Personal Loan?” https://www.experian.com/blogs/ask-experian/what-can-be-used-as-collateral-for-a-personal-loan/

Alternative ways to borrow money

When you need fast access to cash, it may be tempting to use your car as collateral for a loan. But it’s also important to remember that there are other financing options available—many of which don’t require you to risk your source of transportation in the process.

Before you apply for an auto equity loan, consider whether any of the following types of credit make sense for your situation.

Home equity financing

If you own a home, you could consider using the equity in your house to access financing. Home equity loans and home equity lines of credit (HELOCs) are two types of secured loans that allow you to use your home equity as collateral—often to borrow larger loan amounts at lower interest rates, depending on the strength of your credit score and other factors.

Yet like auto equity loans, home equity loans and HELOCs involve risk as a borrower. Specifically, you risk foreclosure (aka the loss of your house) if anything goes wrong and you’re unable to repay your debt according to the terms of your loan agreement.

Unsecured personal loan

With an unsecured personal loan, the lender doesn’t require collateral to back the money you borrow. You may pay a higher interest rate for this type of credit compared to secured financing options like home equity or auto equity loans. But you don’t have to worry about potentially losing a major asset, like your home or car, if you can’t repay your debt. (Of course, there may still be other consequences if you fall behind on unsecured debts such as late collection accounts, credit score damage, and more.)

It’s also important to keep in mind that you typically need at least a fair credit score to qualify for an unsecured personal loan. And if you’re hoping to qualify for a competitive interest rate, most lenders require you to have a good or even an excellent credit score.

Credit card

A credit card might be another financing solution to consider if you need money for a financial emergency. Like loans, credit cards also come in secured and unsecured varieties. But you don’t secure a credit card with the equity you have in a car or home. Instead, if you open a secured credit card you make a cash security deposit with the credit card issuer. The security deposit is typically the same size as your credit limit on your new account.

Of course, the best way to use a credit card is to pay off your full statement balance every month. This good habit can help you build credit and enjoy your credit card benefits without wasting money on credit card interest charges.

When you carry a balance on a credit card, you risk increasing your credit utilization ratio—the relationship between your credit card limit and balance. If your credit utilization ratio increases, your credit score may decline. So, it’s typically only wise to use a credit card if you know you’ll have the cash to repay the debt by the due date on your next statement.

Payday alternative loan (PAL)

If you have bad credit or no credit and need to borrow money, a payday alternative loan (also known as a PAL) might be worth researching. A PAL is a type of small dollar loan available from certain federal credit unions. Credit unions design these loans as more affordable alternatives to predatory payday loans which may have APRs as high as 400%. By comparison, PALs have a maximum APR of 28%. [12] Consumerfinance.gov. “What is a payday loan?” https://www.consumerfinance.gov/ask-cfpb/what-is-a-payday-loan-en-1567/

You may be eligible for a PAL (if your credit union offers this product) once you’ve been a member of a credit union for at least one month. Loan amounts on PALs range from $200 to $1,000. Additionally, you’ll need to repay the money you borrow within six months or less depending on the terms of your loan. You can also access up to three PALs within a six-month period, but no overlaps or rollovers are allowed. [13] MyCreditUnion.gov. “Payday Alternative Loans.” https://mycreditunion.gov/manage-your-money/consumer-loans-credit-cards/payday-alternative-loans

PALs aren’t the most affordable financing option on the market. But if you have bad credit or no credit, they’re certainly a better choice than predatory lending solutions like payday loans and title loans. In the long run, however, your best bet is to work on establishing credit so you have better borrowing options available. Most of all, it’s wise to build an emergency fund you can turn to when you need access to money for unexpected expenses.

Bottom line

Using your car as collateral to secure a loan could be worth considering if you have plenty of equity in your vehicle. But it’s important to make sure you can afford the payments on an auto equity loan before you consider this type of financing. You should also be sure you understand the risks associated with this type of credit—namely the possibility of losing your vehicle to repossession if you can’t keep up with your payments.

If you decide to move forward with auto equity financing, be sure to compare multiple loan offers to find the best deal available for your situation. It’s also a good idea to set aside extra money in savings in case you ever find yourself struggling to make a monthly payment during your loan term. Most of all, be sure to avoid predatory car title loans that feature high APRs and might put you at a higher risk of future financial problems or vehicle loss.

Sources

Michelle L. Black

Michelle L. Black is a leading credit expert with over 17 years of experience in the credit industry. She’s an expert on credit reporting, credit scoring, identity theft, budgeting and debt eradication.

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