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What is an unsecured car loan?

An unsecured car loan is when a credit provider lends you an amount of money that is not secured by the value of an asset. As there is no collateral, if you default on your loan repayments, your lender cannot repossess the vehicle you have purchased with the loan.

Most car loans are secured, as this reduces the financial risk on the lender. If you default on your repayments, the lender can repossess the asset used as security. The asset used as security is typically the vehicle purchased.

Types of Unsecured Car Loans

Fixed Rate: As the name suggests, unsecured car loans with fixed rates charge the same interest rate during the entire loan term. That means that borrowers agree to pay a set amount of interest as part of their regular loan repayments, so repayments never change. This certainty can be appealing, but it could also mean borrowers miss out on rate cuts, because the rate stays the same regardless of whether the lender’s interest rate drop.

Variable Rate: Unsecured loans with variable interest rates means the interest rate on the loan may change during the loan’s term, so your repayments can change too. You can save money if there’s a rate cut, as your repayments will fall. However, if your lender raises the rate, your repayments would increase, and potentially leave you out of pocket if you have a strict budget.

Which is best, fixed or variable?

The best decision for you will depend entirely upon your financial situation.

If you have a strict budget, and you need to know exactly what your repayments will be, a fixed loan may be best. However, you need to be aware of the potential savings you could miss out on if interest rates fall.

If you opt for a variable rate loan, you will get the benefit of rate cuts. However, your loan repayments would rise with any rises in official interest rates. Given that scenario, it might be wise to work on the assumption that your interest rate will eventually rise by up to 3 percentage points, and budget accordingly. This means if your lender does increase the rate on your loan, you will still be able to make your repayments.

How to find the best unsecured car loan

As with all financial products, the best unsecured car loan will depend upon your own financial situation, including your spending and saving habits.

Is it better to get a secured or unsecured car loan?

The main benefit of a secured car loan is that interest rates can be lower. This is because the lender sees this type of loan as less risky, as the car itself or an asset of value is used as collateral. However, if something happens and you can't make your repayments, the lender can repossess the vehicle or asset used as security. This is the main downside.

Benefits of an unsecured car loan

Although borrowers may by charged a higher interest rate on an unsecured car loan, there are advantages to taking out a loan that does not require collateral as security.

Choose the amount you borrow: With an unsecured loan, you can borrow any amount you wish, as long as you prove that you can make the repayments. This amount could include the value of the car as well as other associated costs including insurance fees, registration costs and potentially repairs needed on the car if it is used.

No risk to your property: If you rely heavily upon your car for daily use and don’t want to run the risk of repossession if you cannot make your payments, an unsecured loan could be right for you. Even if you can’t make repayments, you would still have access to your car.

Lower interest rate than other credit: An unsecured loan will most likely charge a higher interest rate than a secured loan, but a lower rate than credit cards or short-term personal loans. If you’re deciding between an unsecured loan and a credit card or short-term personal loan, try creating a table to analyse and compare all fees, charges and rates, so you can make the best financial decision.

Disadvantages of an unsecured car loan

The main disadvantage of an unsecured car loan is that there is a higher financial risk to the lender, so they typically charge higher interest rates and possibly fees and charges.

Higher interest rate than secured loans: Unsecured loans will most often have high interest rates, due to the financial risk associated with giving a loan without security. Also, make sure to investigate all the fees and charges, as this is often where the lender makes money on the loan.

Strict rules on which borrowers qualify: The eligibility criteria is much stricter for unsecured loans than secured as there is no collateral on the loan. Borrowers must have a good credit rating, proof of income and expenses, and sometimes lenders will ask for a deposit to add to security.

Lenders can take legal action: If you do not make your repayments on an unsecured car loan, you will still have access to the vehicle, but could face legal action. Lenders and credit providers can turn your debt over to a collection agency, or file a civil lawsuit to recoup the money that’s owed to them.

Things to look out for with an unsecured loan

Before you decide that an unsecured loan is the best option for you to get behind the wheel of your dream car, there are a few things you need to consider.

Comparison rates: A car loan’s ‘comparison rate’ offers a simpler way to work out approximately how much an unsecured car loan can cost you. Expressed as a percentage, this figure combines the loan’s advertised interest rate with its standard fees and charges. This can then be used as the “interest rate” to calculate the total amount you will pay over the loan term.

Keep in mind that even a car loan’s comparison rate may not take its every cost into account – some non-standard charges and expenses could apply on the loan and not be included in this figure.

Fees for extra repayments: By making extra repayments and paying your car loan off early, you may think you’ll be saving money by reducing the total interest you pay over the lifetime of your loan. However, some lenders charge fees for making extra repayments or paying out a loan early. So, check whether these charges apply to the line you're considering. These fees tend to be more common with fixed rate car loans, though they are sometimes also found in variable rate car loans.

Loan to Value Ratio (LVR): If you don’t have a deposit for your unsecured car loan, you can borrow a greater percentage of your car’s value and smaller upfront deposit. Some unsecured car loans or online lenders will offer 100% of the loan amount, but keep in mind these types of loans are seen as even higher risk, and have much higher interest rates.