With auto equity loans, you have quick access to cash in times of financial need by being able to borrow money against your car. These loans can be a lifeline for covering unexpected expenses and are usually appealing because of their relatively lower interest rates when compared to other types of loans.
However, as with any other secured loan, you risk losing your collateral (in this case, your car) and possibly ending up in a bigger financial bind if you default. As such, it is important to understand how auto equity loans work, their advantages, and potential pitfalls.
What is an Auto Equity Loan?
Auto equity loans are special secure loans that enable you to obtain money secured against your car, with the vehicle’s equity serving as the collateral (for the loan). Vehicle equity refers to the difference between the car’s current market value and any outstanding balance on it.
For instance, let’s say you have a car worth $15,000 and owe $5,000 on an existing loan - your equity would be $10,000. On the other hand, if the vehicle is fully paid off, then your equity is the full $15,000.
In a car equity loan, the lender typically provides an amount based on a percentage of this equity. Some lenders may allow you to borrow as high as 125% of your equity – so, in the case of a fully paid car worth $15,000, you may be able to borrow up to $18,750.
However, this is not generally recommended. Remember that the loan is secured against your car, meaning that the lender has the right to repossess it if you default on repayments.
How Does an Auto Equity Loan Work?
The lender determines how much you can borrow against your car by assessing its value, condition, and available equity. Factors that determine the borrower’s eligibility for an auto equity loan, as well as the offered loan amount, include:
- Vehicle Ownership: Auto loans are typically only offered to individuals who own the car out rightly or have sufficient equity in it.
- Vehicle Condition: The car’s age, use, mileage, and damage/repair condition are considered when determining eligibility and loan amounts.
- Proof of Income: Most lenders require proof of income to ensure that the borrower can repay the loaned amount.
- Credit Score: While credit scores are not necessarily a primary factor when determining eligibility for a vehicle equity loan, most lenders offer better terms to borrowers with good credit scores (usually 700 or higher).
Once the loan is offered, both parties typically sign a loan agreement. This agreement will include the repayment terms and interest rates. Depending on the lender, the repayment plan may be spread over a few months to seven years (or more). Similarly, interest rates also vary based on the lender, the loan term, and the borrower’s credit score, and can range from between 5 and 10% for individuals with good credit to between 15 and 20% (or more), for those with poor credit.
Steps to Get an Auto Equity Loan
Here are steps to take if you wish to get a vehicle equity loan:
- Determine your car’s equity. You can calculate this by subtracting any existing loan balance from its current market value.
- Check your credit score. Knowing your credit score gives you an edge when negotiating terms for the loan, particularly interest rates.
- Compare lenders. Research multiple lenders and compare their loan conditions, interest rates, and other car loan equity requirements to determine the best fit for your specific situation.
- Gather necessary documentation. This usually includes the vehicle’s title (to prove ownership), details on any existing car loans, proof of income, a valid ID, and your credit report (note that the lender will always confirm this on their end).
- Apply for the loan. Once you have determined your preferred lender, officially apply for a loan with them and submit all required documents.
- Review the loan agreement. Be sure to carefully read the terms of the loan, including the repayment plan, interest rates, and any additional fees (such as late payment penalties), before signing the loan agreement.
- Receive funds. Once you sign the agreement, you will typically receive a lump sum for the loaned amount in your bank account. Be sure to stick to the repayment plan to avoid any issues down the line.
Pros and Cons of Auto Equity Loans
As with any type of loan, there are both advantages and drawbacks to auto equity loans:
Pros of Auto Equity Loans
- Quick Access to Funds: Car equity loans provide a faster way to borrow money than traditional loans.
- Diminished Interest Rates: The average interest rates for car equity loans are typically lower than those of other types of secured and unsecured loans.
- Ease of Qualification: Car equity loans are generally easier to qualify for than other types of loans, considering that the only collateral required is a car. This also makes them a preferred option for individuals with a less-than-perfect credit score.
Cons of Auto Equity Loans
- Equity Limitation: You can only borrow against your car to the extent provided by its available equity.
- Risk of Repossession: You run the risk of losing your car if you miss payments on the loan.
- Risk of an Upside Down/Underwater Loan: An upside-down or underwater loan occurs when you end up owing more than the asset is worth. Considering that vehicles depreciate over time, there is always the risk of this happening when you take out a car equity loan.
- Additional Fees: In addition to the interest rates, your vehicle equity loan may come with extra charges, such as appraisal fees, DMV lien fees, and even an early repayment fee.
Tips for Choosing the Right Auto Equity Loan
- Get recommendations from trusted sources.
- Compare multiple lenders.
- Check reviews on your preferred lenders.
- Read the fine print on loan agreements and ensure that there are no ambiguous terms or undisclosed charges before signing the dotted line.
- Borrow only what you need and can comfortably repay.
An auto equity loan can be quite handy during times of need. By understanding the process for getting these loans, you can secure one without jeopardizing your financial stability. However, it is crucial to weigh the benefits of these loans against the potential risks, like falling for a predatory lender.
