There are a number of advantages and disadvantages to financing your next vehicle with an unsecured loan. In addition, there are several factors one should take into consideration when deciding whether or not this will be the best method of financing a new vehicle. The first place to begin before making this decision is doing your research. You will need to know exactly what type of vehicle you want to purchase and how much you can comfortably afford to pay monthly. After that you will need to find out what the vehicle will cost you to purchase. Keep in mind what we want is not always what we can afford. Research will save you a lot of effort, time, and money. Research is the critical step most people miss when deciding on any type of loan will best suit there needs.
The advantage of using an unsecured loan to finance your vehicle is there will be no lien on your vehicle. This can benefit you in three ways. The first benefit is you will now own your vehicle out right. So if for some reason you were unable to make your payments your collateral is secure. Since this is an unsecured loan you can still keep your car even if you are unable to make the payments.
The second benefit is you will not be required to have full coverage insurance on the vehicle since there will be no lien. If you do not have a lien on your vehicle you are only required to carry the minimum insurance coverage which is personal-injury-protection (PIP) and liability. This could save you a substantial amount of money each year on your monthly car insurance (depending on your driving record and other factors).
The third benefit is if your vehicle’s depreciated value is more than what you owe (also known as being upside down or top heavy) you can still sell the vehicle to someone else at whatever the current value is without having to worry about the negative equity. Once the vehicle is sold you then have the option of applying the proceeds to your loan (recommended use) or using them for another purpose (not recommended). Negative equity tends to play a large part in voluntary and involuntary repossessions. This is mainly because most people with negative equity will often trade in that vehicle on a new one and create even more negative equity on the new purchase.
There are some disadvantages to using an unsecured loan for this purpose. The first disadvantage is that unsecured loans for larger amounts are harder to obtain than secured loans. Since there is no collateral to secure, financial intuitions assume a greater risk on these types of loans. Keep in mind when applying for unsecured credit you have to state the purpose of the loan (unless it’s a credit card). Financial institutions will want to know what the money is being used for.
The second disadvantage is the interest rate. The interest rate on an unsecured loan can range anywhere from 3% to 8% more than a secured vehicle loan (depending on your credit and other factors). For example a used vehicle loan for an individual with A+ credit (credit score of 720 and above) at credit union A qualifies for a rate of 4.25%. On the other hand that same individual would qualify for a rate of 9.90% on an unsecured personal loan at the same credit union.
Let’s do the math. A $12000.00 at 48 months at a rate of 4.25 % would give you a payment of $272.49. That same loan at a rate of 9.90% would give you a payment of $304.26. Rounding up that’s an extra $32 a month. That’s $1536.00 over the life of the loan. By going with the used auto loan and adding the extra $32 per month to your payments you would be saving you could pay the vehicle off five and half months sooner.
The third disadvantage is lack of insurance coverage. In today’s fragile economy insurance is something you don’t want to hold back on. When people loose their jobs they have to cut back. I can assure you there are more uninsured drivers on the road then ever before. Having full coverage with uninsured motorist coverage can be a life saver in times like these. At least if an uninsured motorist hits your car, you can still file a claim and have your vehicle repaired with little out of pocket cost to you depending on your deductible.
There is quite a bit to consider when deciding what the best solution would be. Each individual circumstance will be different. The key to making the right decision is taking the time to do the research.