What Is an Auto Equity Loan?

What Is an Auto Equity Loan?

An auto equity loan is a secured loan that lets you borrow against the value of your vehicle, using it as collateral. The loan amount is based on the amount of equity you have in your car. Equity is the difference between the market value of your car and what you owe on any outstanding loans on it.

Vehicles tend to depreciate rapidly, which means you might not have much equity in your vehicle even if you've been paying off your loan for some time. However, you likely have more equity in your vehicle if you made a large down payment or have been paying extra toward your loan consistently.

Example: if your car is worth $10,000 and you owe $6,000, your equity would be $4,000. Some lenders allow you to borrow up to 125% of your equity, which means you could potentially borrow between $4,000 and $5,000 in this example.

To apply for an auto equity loan, you'll need to provide details about your vehicle, such as its value and any outstanding balance on the loan. If approved, the lender will deposit the loan amount directly into your bank account.

Auto Equity Loan vs. Auto Title Loan

Both auto equity loans and auto title loans use your car as collateral, but they differ in a few key areas:

• Auto title loans: These tend to have much shorter terms and higher interest rates. With title loans, you usually can only borrow a percentage of your car's value, and you also may be required to own the vehicle outright.
• Auto equity loans: With this type of loan, your interest rate is typically based on several factors, including your credit score, the vehicle's make and model, the loan amount and the loan term.

Pros and Cons of Auto Equity Loans

Before you apply for an auto equity loan, understand the benefits and drawbacks of this type of credit.

Pros

• Access to cash for emergencies: Once you're approved, you can use the loan for anything, such as medical bills or unexpected home repairs.
• Lower interest rates: Auto equity loans usually have lower interest rates than credit cards and unsecured loans, helping you save on interest.

Cons

• Risk of repossession: If you miss payments, the lender can repossess your car to recover the loan balance. Your credit score may be impacted, making it harder to borrow money for a new car.
• Limited borrowing power: Your loan amount is restricted by the equity you have in your vehicle, which may not be enough to cover your needs.
• Depreciation and negative equity: Cars lose value over time, so if you borrow too much, you could owe more than your car is worth. This could be problematic if you want to sell or trade your vehicle.
• Limited availability: Auto equity loans aren't widely available. While some credit unions offer them, you often have to be a member to apply. Online lenders may offer faster approval but may not have the personal service of local credit unions.

Where to Find Auto Equity Loans

Auto equity loans aren't as common as other types of loans, but are available through many credit unions and online lenders. Credit unions often provide more personalized service but require membership. Luckily, many credit unions have broad eligibility criteria, so joining may be fairly easy. Online lenders offer convenience and faster approval, though you may sacrifice access to an in-person experience due to the lack of brick-and-mortar locations.

How to Get an Auto Equity Loan

To get an auto equity loan, you'll need to follow a few key steps.

1. Determine your vehicle equity. For a ballpark estimate, you can use a vehicle valuation tool like Kelley Blue Book to determine your car's current market value. Subtract your car loan balance from its current value to calculate your equity.
2. Check your credit score. While you're using your vehicle as collateral, lenders will still evaluate your credit score to determine your eligibility, interest rate and loan terms. A higher credit score will help you qualify for a lower interest rate. Review your credit score as well as your credit report for any improvements you can make before applying for a loan. Checking your own credit will have no effect on your score.
3. Compare lenders. Each lender offers different terms. Shop around to find the best interest rates and loan conditions. Getting preapproved or prequalified can help you better understand the terms you're eligible for before submitting a formal application.
4. Complete the application. Provide your personal and financial information, as well as details about your vehicle. Applications can usually be completed online, by phone or in person, depending on the lender.
5. Review the loan offer. After reviewing your application and evaluating your vehicle, the lender will present a loan offer. Carefully review the loan terms including interest rate, loan term and monthly payment amount before signing the loan offer.
6. Repay the loan. If you sign the loan agreement, you'll receive the loan funds as a lump sum deposit to your bank account. Start making your scheduled payments. Consider setting up automatic payments to stay on track.

Alternatives to Auto Equity Loans

If an auto equity loan doesn't seem right for you, here are some alternatives:

• Personal loan: Unsecured personal loans don't require collateral, but often have higher interest rates. The loan amount and interest rate are based on your credit and income.
• Home equity loan: If you own a home, you can borrow against its equity. You may have access to larger loan amounts depending on the equity in your home. Home equity loans offer lower interest rates, but you risk foreclosure.
• Credit card: For short-term borrowing, credit cards provide quick access to funds. However, their high interest rates make them expensive if you can't repay the balance quickly.
• Borrow from family or friends: You may be able to work out more flexible repayment terms by borrowing from someone you know. However, you risk straining or damaging your relationship if you have trouble making payments.

The Bottom Line

Auto equity loans can be a good option for individuals who need cash and have significant equity in their vehicle. However, they come with the risk of repossession and negative equity.

Maintaining a strong credit score can help you qualify for better loan terms, whether through an auto equity loan or other financing options. Before taking on any loan, it's wise to check your credit score and explore all your borrowing options.