Cash-out auto refinance: How to leverage your car's equity to your benefit

About cash-out auto refinancing

Cash-out refinancing isn’t reinventing the wheel. As a process, it’s comparable to home mortgage refinancing, or refinancing an auto loan. Simply put, it uses the equity you have in your vehicle to pay off other debts, or to get extra cash.

When you refinance, you’re essentially replacing a current loan with a new one. There could be plenty of reasons behind this, like lower interest rates or a lower monthly payment. In the case of cash-out auto refinancing though, you’re borrowing against the equity in your car, allowing you access to some of the progress you've made in paying back your loan.

The ‘cash-out’ part comes into play because your new loan will be larger than the outstanding balance of your current loan. With the equity in your vehicle, you’ll be able to cash in on the difference between the loan amount, and this will be deposited straight into your bank account.

If your vehicle is worth more than the remaining balance on your loan, cash-out auto refinancing could be an option for you.

For example...

What would cash-out auto refinancing look like in a real-life scenario? Say you have a Ford Explorer that in today’s market is worth $33,000. Meanwhile, your loan balance sits at $21,000, meaning you have $12,000 worth of vehicle equity. In pursuing a cash-out refinance option, you could cash out a portion of that $12,000 – and see it land straight in your bank account or use it to pay off higher interest loans.

Of course, the exact amount of cash that you’d be able to pull out of your vehicle depends on a number of factors alongside your equity. This can include your credit score and your income, along with the condition of your car. Lender-specific terms may even require taking your car to be physically inspected, along with the addition of their own fees and expenses that reduce the actual payout.

Pros and cons of cashing out a car loan 

Like all refinancing options, there are benefits and drawbacks to taking the cash-out car refinance approach.

While general refinancing can be helpful, the added ‘cash-out’ option can be a real saving grace if you’re in need of spare funds, or to consolidate any other debt you owe at a much lower interest rate than your current debt obligations. Along with this, you may be reaping the standard benefits of refinancing, like a new, lower interest rate and shorter loan periods.

But there’s a flipside. In cashing out funds as a part of your refinance option, you’ll be increasing your auto loan debt obligation, meaning you may end up paying more interest on vehicle financing in the long run. The funds are not immediately available since it takes 3 to 4 weeks to close on the refinanced car loan. Plus, a higher outstanding auto loan could see your repayments extend across a longer period if you extend your term.  A bigger loan might mean you will be making additional payments in the long run. Keep in mind, depending on the lender, you will only be allowed to go up to 100% LTV at time of origination. The LTV limit prevents situations of being upside down at time of loan funding.

The biggest drawback may be that you are replacing unsecured debt (most credit cards and personal loans) with secured debt. If you default on a secured loan, your car will be repossessed. The customer's total debt might also remain the same. For example, if a customer had a $20,000 vehicle loan and $12,000 in credit card debt, they could potentially refinance into a new auto loan for $32,000.

It’s always worth doing the math to work out whether the short-term benefits of receiving a cash-out loan outweigh the long-term drawbacks. For example, the short-term benefits may include having money for important life costs like emergency healthcare or car repairs. However, the long-term effects extend your debt by several more years – potentially pushing a stable financial future further out of reach. Of course, each situation is different, but it’s not a decision to be taken lightly.

When should I look at cash-out refinancing?

There are situations when cash-out auto refinancing may be a great option. With vehicle loans typically coming at lower interest rates than credit cards or personal loans, proceeding with cash-out auto refinance to pay off high-interest debt could help you save money in the long run.

If you’re already looking into taking out a personal loan, or other fast cash lending options, it can be worth considering that cash-out auto refinance offers a direct alternative with better rates. This is because it is secured by something tangible – i.e., your vehicle – unlike unsecured personal loans or credit cards, which is why these have higher interest rates.

There are also times when life throws unexpected expenses at you. A rainy-day fund is a great idea, but for many people it’s just not possible. So, if additional cash is needed to pay for family medical bills, or something big goes wrong with your vehicle and you need spare cash for repairs, it’s good to know you’ve got the option of cash-out refinancing.

Ultimately, the option of cash-out refinance should only be considered for essential expenditure; for your true ‘needs’, and not ‘nice-to-haves’.

When should I avoid cashing out equity?

The decision to pursue cash-out auto refinancing shouldn’t be taken lightly. It’s not worth the risk for expenditures like sneakers or vacations. Similarly, it’s not worth using the cash from the loan as a down payment for a newer car. Ultimately, it is more debt you’re accruing, so using the cash to take on more obligations is unlikely to come without strings attached further down the line.

Car prices have risen of late, making a cash-out refinance option appealing should your car be valued  higher than your loan. But vehicle value can depreciate quickly. So, you could be in for a nasty shock in the shape of negative equity if vehicle values were to go down quickly.

 Also, the amount of equity in your car available for cash-out refinancing may vary depending on its condition and/or history of mechanical problems. The valuations are based on NADA guide values and independent adjustments. For example, having major mechanical problems like a significantly repaired or replaced engine can decrease your vehicle equity. It is also worth keeping in mind, if your loan is about equal to what your car is worth, there is no equity to take out!

If you’re struggling financially, there are situations in which cash-out refinancing may compound your problems. If it means increasing your monthly payment, it could become more difficult to keep up. And if for some reason you are unable to do so, the lender may repossess the vehicle—leaving you without a car, and with a hit to your credit score.

When comparing cash-out to revolving debt, remember the monthly payment on a car loan remains the same for the life of the loan. So, you will have to potentially support that debt for years. By contrast, with revolving debt like credit cards, the monthly payment goes down as the balance goes down, so over time, the monthly debt burden can be easier to handle.

Cash-out versus traditional auto loan refinancing

There are plenty of similarities between cash-out car refinance and your more traditional auto loan refinancing. A wealth of factors need to be considered before pursuing either, to ensure you’re choosing the right option for your financial situation – in both the short and long term.

Unlike traditional auto loan refinance, cash-out refinance means a larger loan than before.

But compare traditional auto loan refinancing with cash-out, and you’ll find similar benefits without increasing the size of your loan. So, if you’ve improved your credit rating, or been making regular and on-time payments over a six-to-12-month period, you can take advantage of the lower interest rates that will likely be available. Plus, you’ll potentially have the option to reduce your monthly payment costs or pay off your loan earlier. All of this, without the added weight of an increased loan.

Summary

A comprehensive review of your own financial circumstances is critical before proceeding with a cash-out auto refinance option. While fast cash may be a short-term priority, there are plenty of long-term pitfalls to consider. Think carefully before choosing to cash out your equity, while traditional refinance is also a solid option.

If you are seeking more information, want to learn about the steps to refinance your car, or have specific questions about cash-out auto refinance, talk to a Caribou loan officer today.

Equity cash-out FAQs

• What is cash-out auto refinancing? The cash-out component of refinancing allows you to use the equity in your vehicle, cash in on the loan amount difference, and deposit the money into your bank account.

• Should I use the equity in my auto loan? Cashing in on the equity could be a good idea if you need the money. One of the biggest drawbacks is replacing unsecured debt with secured debt.

• When should I look at cash-out refinancing? The option of cash-out refinance should only be considered for essential expenditures. Try to use the equity to get money for needs and not nice-to-haves.

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