What Is a Secured Auto Loan and How Does It Work?
Learn how secured auto loans work, where your car secures the financing, affecting loan terms and obligations.
Auto loans are a common financial tool many individuals use to purchase a vehicle. These loans allow consumers to acquire a car by borrowing funds from a financial institution, which are then repaid over a set period.
Defining a Secured Auto Loan
A secured auto loan is a type of financing where the borrower pledges an asset as collateral for the loan. In the context of vehicle purchases, the car itself serves as this pledged asset. This arrangement provides security for the lender, as they have a legal claim to the vehicle if the borrower fails to meet the repayment obligations. This contrasts with an unsecured loan, which does not require collateral and is instead approved based on the borrower’s creditworthiness.
Because collateral reduces the lender’s risk, secured auto loans typically offer more favorable terms than unsecured loans. The agreement between the lender and borrower in a secured loan grants the lender a claim on the vehicle. This means that while the borrower uses the car, the lender maintains a legal interest in it until the loan is fully satisfied. This claim is formally documented to protect the lender’s interest.
The Role of the Vehicle as Collateral
The vehicle’s role as collateral in a secured auto loan is formalized through a legal claim known as a lien. When a loan is originated, the lender places a lien on the vehicle’s title, signifying their legal right to the car until the debt is fully repaid. This lien is typically filed with the state’s Department of Motor Vehicles (DMV) or equivalent agency.
For the borrower, this means that while they possess and use the vehicle, they do not hold full, unencumbered ownership. The lender’s name is listed on the vehicle’s title as the lienholder, indicating their security interest. This legal arrangement prevents the borrower from selling the vehicle without the lender’s permission or without first satisfying the outstanding loan. Once the loan is completely paid off, the lender releases the lien, and the borrower receives a clear title, signifying full ownership.
Key Aspects of Secured Auto Loans
Secured auto loans often come with interest rates that are lower compared to unsecured alternatives. This is due to the reduced risk for the lender, as the vehicle acts as collateral. For instance, in the first quarter of 2025, the average interest rate for new secured car loans was approximately 6.73%, while used car loans averaged around 11.87%.
The repayment structure for these loans involves regular payments that cover both the principal amount borrowed and the accrued interest. Loan terms, which dictate the duration of repayment, commonly range from 24 to 84 months. While a longer loan term can lead to lower monthly payments, it typically results in a greater total amount of interest paid over the life of the loan.
If a borrower fails to make payments as agreed, the loan enters default. Upon default, the lender has the right to repossess the vehicle to recover the outstanding debt. This repossession can occur without prior notice in many states, and lenders may initiate the process as soon as a payment is missed, though some might allow a grace period of 30 to 90 days.
Following repossession, the vehicle is typically sold, often at auction. The proceeds from this sale are applied to the remaining loan balance, as well as any repossession and sale costs. If the sale price does not cover the full amount owed, the borrower may still be responsible for the difference, known as a deficiency balance.