5 Types of Collateral for Auto Loans

Using collateral for auto loans will significantly reduce the cost of the loan by lowering the interest rate. With collateral, the borrower is assuming more of the risk than the lender. This allows the lender to offer lower rates and more flexible terms. Consider these sources of potential collateral:

#1 The Car Itself

Nearly every auto loan uses the car being financed as collateral. The lender holds on to the car title until the loan is paid off, and the car changes ownership. If the borrower defaults on the loan during this period of time, the lender seizes the asset. If a borrower has particularly low credit or no down payment at all, the lender may ask for additional collateral on the loan.

#2 Another Vehicle

The most obvious source of additional collateral is another vehicle. If a borrower wholly or partly owns a second car, the equity owned in this car can be placed as an asset on the new car loan. Whenever a car is used as collateral on any type of loan, the lender may have new insurance requirements. There is also a limit to the number of liens that can be placed against a car; usually, this limit is two at one time.

#3 Home Equity

Home equity is a solid source of collateral for a number of large loans. A home's value tends to go up over time, which means the collateral maintains a stable or increasing value. This helps protect the lender from the possibility an asset may be worth less when seized to recover loan payments than it was when the loan was issued. Added protections on the loan tend to make loan rates even lower. A borrower does not need to fully own a home in order to use it as collateral. Even 20% ownership in a home can generate the equity needed to serve as collateral on a car loan.  

#4 Stock Certificates

You do not need to liquidate your investment accounts in order to get the cash to make a major purchase. Instead, consider using stock or bond certificates as collateral on a loan. A lender can hold the certificates in trust while the loan is alive. If you default on the loan, the lender can seize and liquidate the stocks to cover losses. The biggest benefit with this option is you continue earning dividends and interest on the stocks while they are held. This essentially reduces the cost of the interest on the loan.

#5 Savings Account

A savings account can be used as an easy collateral option, particularly if you are getting a loan from a bank. Again, instead of liquidating the account, you can keep the funds in savings and allow them to earn a moderate interest. This interest can be deducted from the interest rate on the auto loan to reflect the real expense of the loan. You will not be able to deduct the portion of the account that is serving as collateral while the loan is alive. However, you can still contribute to the account and make withdrawals that do not affect the amount used for collateral.

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