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A cash-out auto refinance allows you to replace your existing auto loan with a new, larger loan and pocket the difference between the two.
The new loan allows you to gain access to some of the progress you've made in paying off your vehicle, but it might not make financial sense in your situation. Here's what you need to know about how the process works as well as some of the potential risks involved.
How Does a Cash-Out Auto Refinance Work?
If your vehicle is worth more than the remaining balance on your loan, you may be able to do a cash-out auto refinance.
Like a regular auto refinance, your new loan will cover the remaining balance on your original loan and possibly nab you a lower interest rate or a modified loan term. Where a cash-out auto refinance differs, however, is that your new loan will be larger than your original loan. The difference between the loan amounts will be deposited into your bank account to be used to make purchases, pay bills or consolidate debt, for instance.
A cash-out auto refinance is similar to a cash-out refinance mortgage loan, which gives you the ability to replace your current mortgage loan and take some of the equity you have in your home in cash.
For example, let's say your car is worth $10,000, but your loan has a remaining balance of just $2,000. You may be able to refinance your loan for up to $10,000 and take the $8,000 difference in cash.
The amount you can get in cash will depend on a few factors, including how much you owe, the value of the vehicle and the lender. Some lenders may allow borrowers to get a new loan that's 100% of a vehicle's value, but actual terms can vary.
When you apply for a cash-out auto refinance, a lender will review your existing loan information, determine the value of your vehicle, and review your credit and financial information to determine whether you qualify.
Just keep in mind that not all lenders that offer auto refinance loans allow cash-out options. As a result, you may need to take some time to research and compare the lenders that do.
When Could a Cash-Out Auto Refinance Make Sense?
There are a few situations in which it might be a good idea to tap your car's equity through a cash-out auto refinance:
- You can get better loan terms. If your new loan would have a lower interest rate than your current one, refinancing with or without cash back may be a good idea. Securing a lower rate is more likely if your credit score has improved or market interest rates have dropped since you took out your original auto loan. And if you need a little cash for something else, a lower interest rate could keep your monthly payment around the same as it was on your original loan.
- You want to consolidate debt. If you qualify for a low interest rate on an auto refinance loan, but you have higher-interest debt you want to pay off, getting cash back on your refinance loan could allow you to pay off that more expensive debt, essentially consolidating it into the low-interest loan. Consolidating unsecured debt this way will convert it to secured debt, meaning you risk repossession if you're unable to pay it back.
- You have emergency expenses. If your financial situation is tight, a cash-out auto refinance could be a relatively inexpensive way to get some cash to pay for emergency expenses. With good credit, you can get a much better rate with an auto refinance loan than with a personal loan or credit card.
Consider your situation to determine whether a cash-out auto refinance can help you.
What Are the Risks of a Cash-Out Auto Refinance?
While using your vehicle's equity to consolidate high-interest debt or cover emergency expenses can be helpful, it's also important to understand the potential pitfalls that could make your financial situation even worse:
- You could increase your existing debt. If you're using a cash-out auto refinance to pay for emergency expenses, increasing your debt—and associated monthly payments—could make your situation even more challenging. Unless you're certain you'll be able to afford the higher monthly payments, look elsewhere for relief.
- You could go upside down on your loan. Most vehicles depreciate fairly quickly, potentially faster than you can pay down the loan balance. If you borrow 100% of your car's value or close to it, rapid depreciation could mean you end up with negative equity. If you end up selling the car or total it in an accident, you may be on the hook for the difference between the car's value and what you owe on the loan.
- You run the risk of repossession. If you're struggling financially, increasing your monthly payment with a cash-out auto refinance loan could make it increasingly difficult to keep up. If you stop making payments, the lender may repossess the vehicle—leaving you without a car and a negative mark on your credit report to boot.
Make sure you're considering both the benefits and the drawbacks of a cash-out auto refinance before you pull the trigger.
How Does Refinancing an Auto Loan Affect Credit?
In general, refinancing your auto loan won't have a significant impact on your credit score. When you first apply for the loan, the lender will run a hard inquiry on your credit report, which can temporarily lower your credit score by a few points.
Keep in mind that when you're shopping around, all of your hard inquiries will be combined into one for credit score calculations, as long as you complete your rate-shopping within a short period—14 to 45 days depending on the credit score model being used.
If approved, the new auto loan will also reduce your average age of accounts, which impacts your length of credit history. And, of course, if your new loan is higher than your old one because you took cash out of your vehicle's equity, it could impact your amounts owed.
However, as long as you make your payments on time and manage your other debts well, you likely won't see any long-lasting negative effects with an auto loan refinance.
Should You Do a Cash-Out Auto Refinance?
There's no one-size-fits-all answer to whether a cash-out auto refinance is right for someone or not. As such, it's crucial that you take the time to consider your situation, your reasons for wanting one and other alternatives you have to accomplish your goal.
Also, be sure to check your credit score before you start applying. The higher your credit score, the better your chances will be of scoring favorable terms on the new loan. If your credit isn't where you want it to be, it may make sense to take steps to improve your credit before you apply for a new auto loan.