What is cash-out refinancing on an auto loan?

Cash-out refinancing means that you refinance for more than what you currently owe on your car. The amount you can borrow is based, in part, on the equity you have in the vehicle. If you’re approved for a cash-out refinance, it can allow you to get new loan terms and some money in your pocket for other expenses or an emergency.

Let’s take a look at how cash-out refinancing of an auto loan works compared to traditional refinancing, as well as some things to consider before you decide to go this route.

• What happens when you refinance a car loan?
• What is a cash-out refinance auto loan?
• Is a cash-out refinance loan worth it?

What happens when you refinance a car loan?

With a traditional refinance, you take out a new loan to pay off your current loan.

If your credit scores have improved or interest rates have dropped in the time since you got your original loan, you might be able to get a lower interest rate on a new loan, which could help you save money. You may also be able to save on your monthly payment if you extend your loan term. Just keep in mind that you’ll likely end up paying more in interest if you choose a longer loan term.

What is a cash-out refinance auto loan?

Cash-out refinancing involves applying for a new car loan to cover the remaining balance on your original loan, plus an extra amount. How much you can apply for depends on the lender and how much equity you have in the car. And if you’re approved, the funds may be released in a lump sum, though it can vary by lender.

Let’s say you’re approved for a cash-out refinance loan for $13,000 to cover your original auto loan of $10,000, plus borrow another $3,000 from the equity you have in the car. You’ll get $3,000 cash in hand and be responsible for paying down the $13,000 cash-out refinance loan with monthly payments and interest.

You could use this extra money for debt consolidation — paying down other high-interest debt, such as a balance on a credit card or loan — but this is a good idea only if the interest rate on your refinance loan is lower than your current loan. You could also use the cash to handle a financial emergency.

How much cash can I get with cash-out refinancing?

The amount of extra cash you can borrow depends on several factors.

• Your car’s value — Because you’re borrowing against your vehicle’s equity, your lender might require an in-person inspection of your car to assess its value.
• Your credit — If your credit is less than perfect, you may have a difficult time getting approved for an amount that’s much higher than your car’s value.
• The lender — Some lenders may set a limit on how much extra you can borrow through cash-out refinancing, while others may allow you to borrow up to 100% of the vehicle’s value — if you have the equity in the car. Be sure to do your homework beforehand to understand any loan amount restrictions.

Is a cash-out refinance loan worth it?

While a cash-out refinance loan may seem like an easy way to refinance your auto loan and borrow some cash, it could come with some drawbacks.

It may not fit your monthly budget.

If you aren’t able to get a better interest rate than you had on your original loan, refinancing probably isn’t a good option. That’s because you’ll likely increase the amount of interest you pay over the life of the loan. But even if you’re offered an interest rate that’s slightly lower, the terms of the new loan may lead to a higher monthly payment. You’ll have to decide what works for your monthly budget.

Here’s an example. Let’s say you took out a $20,000 auto loan with an 8% interest rate and 60-month term. Your monthly payment would be $406.

Then, a couple of years into your loan, you decide to get a cash-out refinance loan. When you refinance the roughly $13,000 remaining on the loan, plus $4,000 in cash — with a 48-month loan term and an interest rate of 7.5% — your monthly payment would be $411.

You run the risk of becoming upside down on your car loan.

When you owe more on your auto loan than your car is worth, you’re considered upside down on your loan. With cash-out refinancing, your risk of becoming upside down could increase, depending on how much you borrow against your car’s equity. This is because your car continues to depreciate, or lose value, over time.

Making extra payments or paying off your cash-out refinance loan early could help you avoid becoming upside down. But check to make sure your lender doesn’t charge a prepayment penalty fee — otherwise, you’ll have to pay a fee if you pay off your loan early.

You’re increasing your debt.

With a cash-out refinance, you take on more debt because you’re borrowing more than what you currently owe on your original auto loan. If you’re already struggling to make your car loan payments, increasing your debt could put you at greater risk of defaulting on your new cash-out refinance loan and having your vehicle repossessed.

What’s next?

Cash-out refinancing could be a way to get better loan terms and some cash in hand. But as with any loan, it’s important to shop around first to find the right refinance loan for you.

If you apply for prequalification and get prequalified with several lenders, it can help you gather and compare potential loan offers — typically without an impact to your credit scores. Just remember: Prequalification doesn’t mean you’re actually approved for a loan, and the terms that you see are estimates. But it can give you an idea of whether you might be approved and at what terms.

If you decide that a cash-out refinance loan isn’t for you, consider whether a personal loan might be a better option for getting some cash.