What is a car equity loan? – Forbes Advisor

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Although auto equity loans are not very common, they allow you to borrow against the equity in your car. Your equity is the difference between your car loan balance and the current value of your car. If you have equity in your car and need to borrow some money, this could be an option worth pursuing.

We’ll explain how home equity loans work to help you decide if this type of personal loan is right for you.

How Auto Equity Loans Work

When you take out an auto loan, your lender will offer you a loan based on the equity in your car. If you have paid off your car loan and you owe it frankly and clearly, your principal would be equal to the current market value of the car. If you still owe money on your loan, your equity would equal the current value of the car minus your loan balance.

For example, if the car is worth $20,000 and you owe $5,000 on it, you have $15,000 of equity ($20,000 – $5,000).

However, each lender sets their own rules regarding the maximum amount you can borrow. Some will allow you to borrow your entire principal (like the $15,000 in the previous example) while others offer loans of up to 125% of your principal, which would equal $18,750 in this case. ($15,000 x 125%)

When is a car equity loan the right choice?

A car loan may be a good option if:

  • Looking for lower interest rates.
  • You have a good amount of accumulated equity in your car.
  • You struggle to qualify for other traditional loans.
  • You are certain that you can afford the loan so that you do not risk repossessing your car.

How to get a car equity loan

Getting a car loan is a little different from applying for a personal loan. Although lenders may set their own rules for the application process, here are some guidelines you can follow:

  • Make sure you have equity: If you don’t have equity in your car, you won’t be able to get a car equity loan. To calculate your auto equity, subtract the amount remaining on your auto loan from the value of your car (as determined by Kelley Blue Book or a similar resource).
  • Find a lender: Auto equity loans are not that common, especially at large banks. Your best bet is to check with local credit unions and your current auto lender (if you still have a loan).
  • Apply for the loan: Besides the normal details such as your income and credit score, lenders will want to know the details of your car so they can establish its value. They will also want to see the details of any car loans you have so they can calculate and verify your principal.
  • Repay your loan: If you are approved, congratulations! Remember to make all your payments on time. You can sign up for automatic payment so you don’t miss any payments.

Auto Equity Lending vs. Auto Title Lending

Auto equity loans and auto title loans are loans based on the amount of equity you have in your car. Lenders are also likely to require you to offer your title as collateral until you repay either type of loan.

However, auto title loans tend to be riskier. They charge very high rates, even on par with payday loans. These high fees can make it difficult to meet your repayment obligations and cause the lender to seize your car. For example, according to the Consumer Financial Protection Bureau, about 20% of auto title loan borrowers have their car repossessed.

Auto title loans also tend to be short-term loans, typically a month or less. Auto equity loans, on the other hand, can last for months or years, just like with a traditional auto loan.

If you’re hesitating between the two, we recommend sticking with auto equity loans.

Benefits of auto equity loans

  • Offer low rates: Auto equity loans are secured, which means your car acts as collateral and lenders can repossess it if you don’t pay. Because collateral makes these loans less risky, lenders offer lower rates.
  • Approvals can be easier: Again, since auto equity loans are less risky for lenders, it may be easier to get than an unsecured loan, which is based solely on your credit and financial situation.
  • You don’t need to own: The other type of home equity loan is a home equity loan, but not everyone is a homeowner.

Disadvantages of auto equity loans

  • This may mean working with multiple lenders: If you get an auto loan from a lender other than your primary lender (if you’re still paying off the car), that can complicate things. You will have two loans to pay, manage and track.
  • You can potentially lose your car: Because these are secured loans and your car acts as collateral, you can lose your car if you fall behind on your payment or fail to repay your loan.
  • They are not widely available: You may have trouble finding a lender for an auto loan. They tend to be more common in credit unions, but you may not be eligible depending on its membership requirements.

Alternatives to auto equity loans

The good news is that aside from auto equity loans, you have plenty of options for borrowing money if you’re in need, including:

  • Home equity loans. If you are a homeowner, you can tap into the equity in your home, similar to an auto equity loan. Since mortgages are much larger than car loans, you may be able to borrow more money with a home equity loan.
  • Personal loans. Personal loans are a great option if you need funds to cover various expenses, including medical bills, emergencies, or home improvement projects. There are even personal loans for bad credit, and while their rates may be higher than traditional personal loans, they are much lower than payday loans.
  • Credit card. Credit cards are versatile tools that allow you to borrow money as needed up to your credit limit. You must pay off your balance each month, and any outstanding balance will start earning interest.

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