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Though it's not uncommon for American drivers to purchase used cars in cash-only private party transactions, most new car buyers use auto loans to finance their rides. As the economy heats up, more Americans are taking on auto loan debt — nearly $1.2 trillion in outstanding loans, according to The Atlas.

However, there are different types of auto loans. If you're new to the auto loan space, be sure to review the common and not so common varieties of auto loans that exist.

Secured Auto Loans

Many auto loans are secured. This means that they're guaranteed by a lien on the underlying asset — in this case, the vehicle. If you fall behind payments, your lender has the legal right to seize, or repossess, the vehicle. Once the loan is paid off, the lien is lifted and the lender no longer has the right to repossess the vehicle.

Since they're less risky for lenders, secured loans tend to carry lower interest rates than comparable unsecured loans. If the overriding concern is securing the lowest possible interest rate on your loan, seek out a secured option. However, bear in mind that other factors may affect your interest rates, such as your credit score and loan term.

Unsecured Auto Loans

Unlike secured auto loans, unsecured loans are not secured by the underlying asset. Since lenders aren't permitted to place liens on vehicles financed with unsecured loans, they can't repossess them when borrowers become delinquent.

Due to greater lender risk, unsecured auto loans have higher interest rates than comparable secured loans. Your exact rate will depend on your credit profile and other factors.

Simple Interest Auto Loans

Simple interest loans' outstanding balances accrue interest on a periodic basis, often daily. Borrowers must make monthly payments, but they can accelerate payoff and limit interest expenses by making larger or additional principal payments. Simple interest loans are therefore more flexible for borrowers with some breathing room.

If you have substantial personal savings or expect your cash flow to increase (perhaps due to a raise at work or falling household expenses) in the future, opting for a simple interest loan may reduce your total borrowing costs.

Pre-computed Auto Loans

Pre-computed loans are not as flexible as simple interest loans. Borrowers must make scheduled payments on a pre-determined basis with each payment assigned a precise share of the loan's principal and interest. Accelerated payments don't reduce the total principal and interest owed over the life of the loan — they merely front-load the payoff.

If you have a limited budget or anticipate an adverse change to your financial picture in the future, a pre-computed loan that allows for a predictable payment schedule may be your best choice.

Other Auto Loan Types

Here are two less common loan types that are usually reserved for special circumstances — but they don't apply to all car buyers.

  • Lease Buyout Loans: This type of loan provides a path to full ownership for lessees who want to keep their vehicles past the end of their lease terms. The lender pays the lease buyout fee upfront and the borrower makes fixed payments over a pre-set term. Once the lease buyout loan's principal is paid off, the lender's lien is lifted and the borrower owns the vehicle free and clear.
  • Title Loans: This type of secured loan is reserved for people who own their cars outright. Like a home equity loan, a title loan allows you to borrow directly against the value of your car. Once the loan is issued, the lender places a lien on the vehicle and takes possession of the title. The borrower retains use of the vehicle, though the lender has the right to repossess if the borrower becomes delinquent.

Disclosures

This information and recommendations contained herein is compiled from sources deemed reliable, but is not represented to be accurate or complete. In providing this information, neither KeyBank nor its affiliates are acting as your agent or is offering any tax, accounting, or legal advice.

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