Unlike homes, cars generally lose value over time. However, if you have equity in your vehicle, you may be able to tap that value with a cash-out auto refinance loan.
Getting a cash-out car refinance is a relatively simple process, but there are some potential risks involved. Understanding how they work can help you determine whether getting one is right for you.
[SEE: Compare Auto Refinance Loans, Lenders and Rates]
What Is a Cash-Out Refinance Auto Loan?
Similar to a cash-out mortgage refinance
, a cash-out auto refinance allows car owners to access some of the equity they have in their vehicles. For example, if you owe $20,000 on your auto loan and the car is worth $30,000, you have $10,000 in equity.
If you refinanced your loan with a new loan for $30,000, you would receive the $10,000 difference in cash, via direct deposit into your bank account or a check.
One major difference between cash-out loans for cars and homes, though, is the maximum amount you can borrow.
With a cash-out mortgage refinance, many lenders only allow you to borrow up to 80% of your home’s value, though some may go higher. With an auto cash-out refinance, however, you may be able to go as high as 130% of the vehicle’s value. This percentage is called the loan-to-value ratio.
Additionally, cash-out auto refinances typically don’t come with upfront costs. In contrast, a cash-out mortgage refinance may require closing costs costing up to 6% of the loan amount.
Finally, while a cash-out home refinance can take a month or two to close, a cash-out car refinance can take just a week or two.
[READ: Best Auto Loan Rates and Lenders.]
How Does a Cash-Out Auto Refinance Work?
To get an auto cash-out refinance, you’ll start by reaching out to lenders directly to submit applications. Some may even allow you to get preapproved before you apply. You can also contact your existing lender to see if you can accomplish your goal without switching to a new financial institution.
Before you submit an application, though, review each lender’s website to get an idea of what the requirements are and how much you can borrow.
Note that many lenders may not specify on their website or even in their applications that they offer a cash-out option. In this case, you may need to speak with a loan officer to determine whether you can do it.
Once you’ve submitted your application, lenders will typically use a valuation guide like the National Automobile Dealers Association book to determine the value of your vehicle. They’ll also consider the car’s age and mileage — some lenders may deny your application if the car is too old or has too many miles. Finally, they’ll run a credit check to determine your eligibility and interest rate.
Once the underwriting process is complete, the lender will let you know your rate offer, as well as how much you can borrow based on your application details, the value of your car and its loan-to-value limit. You can borrow up to the amount the lender offers or less than that. Review and sign the loan agreement, and you should receive your funds within a few business days.
Pros and Cons of a Cash-Out Auto Refinance
A cash-out auto refinance can be a good option for some vehicle owners, but there are some risks to consider before you apply.
Pros
— It can provide inexpensive financing. If you need money for debt consolidation, home improvements or other purposes, you may be able to get a much lower interest rate with a cash-out car refinance compared with a personal loan. You also won’t have to deal with the expensive closing costs of a cash-out mortgage refinance or home equity loan.
— You could get a better rate. If your credit score has improved since you took out your existing auto loan or interest rates have fallen in general, you may be able to secure a lower interest rate than what you’re currently paying.
— You could lower your monthly payment. Depending on the terms of your existing auto loan and the new one, you could potentially secure a lower monthly payment. This may be especially true if your cash-out loan balance is lower than your initial auto loan balance.
Cons
— You may end up underwater on your loan. If you borrow more than your car is worth, you’ll immediately have negative equity in the vehicle. If the car gets totaled or you try to sell it, you’ll have to pay the deficiency balance out of your own pocket. Even if you don’t exceed your car’s value with your loan, the vehicle could depreciate faster than you pay it down, which can still result in you being underwater.
— You could end up paying more. If you can’t get a lower interest rate, the new loan could become costly — both in terms of a higher monthly payment and the additional interest you’ll need to pay. Even if you can secure a lower interest rate and monthly payment, you’ll typically extend your repayment term as part of the refinance. That means you could end up paying more in total interest. “Don’t use your car as an ATM at a higher rate for a long period of time,” says Steven Gordon, senior director of finance at Way.com, a car services app.
— You could risk repossession. Depending on the terms of your current car loan and the new one, you could end up with a higher monthly payment. If you can’t afford that payment, you could end up in default and risk having the vehicle seized.
When to Consider a Cash-Out Auto Refinance
Refinancing your auto loan to get cash out of the equity can be a good option for some, but not all. Here are some situations where it might make sense:
— You’re not planning to borrow more than your car is worth.
— Your credit score is in great shape, and you can get a comparable, or even lower, interest rate.
— You can comfortably afford the new monthly payment.
— You need some money for a good purpose and want to minimize your interest costs.
— You don’t own a home, or you want to avoid the high closing costs of a cash-out mortgage refinance or home equity loan.
“A cash-out refinance loan can be a good idea when you know you have a good hold on your finances and can take on the extra debt,” says Lyle Solomon, principal attorney at Oak View Law Group, a debt relief firm. “It’s vital to check your spending habits before you consider taking out a cash-out refinancing loan.”
If you opt for a cash-out refinance, though, try to avoid extending your repayment term by a lot. “Extending out the refinance loan for 84 months just to have a lower payment when you have less than two years left on your current loan, unless this is the only way you can afford to keep the car, is not a smart move,” says Gordon.
[Read: Best Mortgage Refinance Lenders.]
Alternatives to a Cash-Out Car Loan
If you’re considering using a car refinance to access some of your equity, it’s important to consider all of your options before proceeding. Depending on your need for the cash, here are some potential options:
— Cash-out mortgage refinance. If you need to borrow more than a cash-out car refinance allows, you may consider doing it with your home instead. This may be particularly helpful if mortgage rates are low and you have a significant amount of equity in your property.
— Home equity loan or line of credit. Getting a home equity loan or a home equity line of credit can be worth considering if you need more money but don’t want to refinance your primary mortgage. In particular, a HELOC can be advantageous if you want ongoing access to credit instead of a one-time loan.
— Personal loan. If you want to avoid the risk of losing your car, consider an unsecured personal loan. Interest rates may be higher, but if you have excellent credit, you may still be able to score a single-digit interest rate.
— 0% APR credit card. If you have good credit, you may be able to get approved for a credit card with an introductory 0% annual percentage rate on purchases, balance transfers or both. Just make sure you can pay off your balance before the promotional period ends to avoid a high interest rate. Also, keep in mind that you won’t know what your credit limit will be until you get approved. Your card limit might not be high enough to cover the purchase you had in mind.
Take your time to consider all of your options and pick the one that best fits your needs and can help you save the most over the long term.
[SEE: Compare Auto Refinance Loans, Lenders and Rates]
More from U.S. News
Can You Buy a Car With a Personal Loan?
How the New EV Tax Credit Will Affect Your Auto Loan
Is a Cash-Out Refinance a Good Idea?
What Is a Cash-Out Auto Refinance? originally appeared on usnews.com
