Vehicle ownership is a significant decision for most people and comes with various financial responsibilities, such as paying monthly car loan premiums and local taxes and buying car insurance. You balance these costs with your rent or mortgage payments, food budget, utility bills, and other regular expenses. Sometimes, you might require additional funds to tide you over for the time being or pay for emergencies.
In such a case, if you have a good amount of equity in the vehicle you own, a cash-out auto refinance could be an option you might want to consider. With cash-out refinancing, you can borrow money against the equity in your vehicle and include that amount into your refinanced loan to repay over time.
What Is a Cash-Out Auto Refinance?
A cash-out auto refinance involves applying for a new, larger car loan to replace your existing car loan. Many people buy vehicles on loan and pay monthly premiums toward it. When you have paid off a portion of your loan, that amount becomes the equity in your car. So, the equity is the car’s value minus the balance you owe on your auto loan.
You can convert the equity to cash with a cash-out auto refinance. That means you get a larger car loan than your existing one and get part of it in cash. For example, let’s say your car is worth $20,000. If your existing car loan is $10,000, and you need an extra $3,000 for an unexpected expense, you could take out a cash-out refinance loan for $13,000. This will pay off your previous loan, and give you $3,000 cash to use for essentials like medical bills, home repairs, or higher interest debts.
How Does a Cash-Out Refinance Work?
To obtain a cash-out refinance, you can take the following steps:
1. Find Out Your Car’s Value
It is first necessary to find out the current market value of your used car. You can do so by reviewing prices for similar models on NADA, Kelley Blue Book, and other websites. Once you know the market price, you can check how much you owe on your existing car loan to find out how much equity you have in the car.
2. Research Car Loan Lenders
The next step is researching the different lenders that offer cash-out refinancing and getting informed about their loan terms. You can then narrow it down to a lender that meets your requirements. Here are some factors to consider when choosing a lender:
- Some lenders may let you borrow limited cash, while others will allow you to borrow up to 100% of the amount your car is worth if you have sufficient equity in the vehicle
- Some lenders will only refinance cars less than 10 years old with under 125,000 total miles driven
- Some lenders may require you to have more than a specified amount remaining on your loan
3. Submit a Loan Application
After selecting a lender, you can submit a loan application for a cash-out refinance. After reviewing your application, the lender will check your credit score and use the information to determine the interest rate they can charge you. They will evaluate your income and existing debts to make sure that you are financially capable of repaying the new loan. The debt you will need to pay every month should not be more than 45% to 50% of what you earn in your monthly income.
4. Get Your Car Inspected
The car loan lender will inspect your vehicle to assess its current value and mileage. The current car value minus the balance you owe on your car loan is the equity that can help you refinance your loan. You are more likely to get approved for the loan if the car equity can cover the loan refinancing and the additional loan and if the car is well-maintained and under 10 years old.
5. Receive the Loan
After the lender approves your application, they will send you the cash by check or direct deposit. You can use the money to pay off your existing car loan and spend the remainder as needed. Some lenders may restrict you from using the loan money for gambling, investing, or repaying educational debts. As per your agreement with the lender, you can then start repaying the car loan with monthly payments and interest.
Is a Cash-Out Refinance a Good Idea?
Your personal situation will determine if a cash-out refinance on your car loan is a suitable option for you. Here are some pros and cons to consider:
Pros of Cash-Out Refinancing
The benefits of cash-out refinancing are:
- You might get an extended loan term with lower interest rates and lower monthly payments
- You can get a lump sum cash amount to meet your immediate requirements
- You can use your car as collateral, and the loan you get on it will be a lower interest alternative to securing a personal loan, a credit card loan, or any other unsecured loan
- You can get a lower interest rate on the loan if your credit score has improved or interest rates have gone down since you got your existing car loan
Cons of Cash-Out Refinancing
The disadvantages of cash-out refinancing are:
- You will be taking on additional debt
- You might have to pay a higher interest rate on the new loan
- You might end up paying more interest on the new loan if you choose an extended loan term
- You may not qualify for a lower interest rate on the new loan or get a higher interest rate, and this could increase your monthly expenses
- You might end up owing more on your vehicle than its actual value since cars depreciate over time
- You could have your vehicle repossessed by the lender if you stop making monthly payments and default on the car loan
- You might not be able to repay the loan with your car insurance if your car gets totaled in an accident
- You might not benefit much from the cash-out refinance if you do not have sufficient equity in your vehicle
While a cash-out refinance can help you fulfill your immediate cash requirements, many experts advise exploring other forms of financing first. For example, you might consider asking family or friends to help you out, getting a personal loan, or applying for a traditional loan. These options might be more effective in the long run because cars depreciate over time, and you could end up being upside down on your loan.
At FIXD, our mission is to make car ownership as simple, easy, and affordable as possible. Our research team utilizes the latest automotive data and insights to create tools and resources that help drivers get peace of mind and save money over the life of their car.
