If you have ever tried to take a car loan, you would’ve probably heard the term “equity” in the conversation with the loan officer. If you were wondering what vehicle equity means, don’t worry, the answer is quite simple. It’s nothing but the difference between your car’s value and the loan amount owed to the bank. The math is pretty straightforward on this. If you have a $20,000 car and your loan balance is $8,000, you will possess $12,000 in vehicle equity. Once you finish paying the loan off, your vehicle equity will be the value of the car, i.e. $20,000. However, this amount depends on the value of the car once you finish paying your loan amount. Most cars depreciate with time. So by the time you finish paying your car loan off, your vehicle’s value would’ve reduced from the value when it was new. Sometimes, your car’s value can become lower than the money you owe while you are still repaying the loan. This situation is known as having negative equity or being “upside down” on the loan. Some collectible cars tend to increase in value with time but most cars lose their value over time. Let’s find out more.
Your Vehicle’s Equity: All You Need To Know
How to use your vehicle’s equity?
If you want to use your vehicle’s equity, you will have to refinance your car. Work with the institution that issued your existing auto loan and get a new auto loan. If this loan is approved, your current loan will be waived off and an amount equivalent to your car’s equity will be sent to your account. Continuing with the example we used in the intro, if you are approved for the car’s full value of $20,000, your remaining loan of $8,000 will be waived off and you will be able to use the remaining $12,000 wherever you want. If you don’t have a pre existing loan, you will have the option to finance the entire value of your car.
What are some advantages of using your vehicle’s equity?
When you take a car loan, some financial institutions might allow you to use your vehicle equity. You can get the car loan for the car’s value and utilize the money for something else as well. You can really take advantage of this as car loans tend to carry lower interest rates than many other kinds of loans such as credit card loans. In case you need to repair your television and you are out of cash, you can use the vehicle’s equity to pay for the repairs. The interest rates would be much lower when compared to a credit card loan. You can also clear your other outstanding debt such as outstanding student loan debt, taking advantage of the low interest rates.
What is a car loan?
A car loan is basically a normal installment loan. Most car buyers choose between dealer financing and an independent bank car loan. The car loan from an independent bank is usually earmarked. Because of this, it offers better interest rates than an untied installment loan. Earmarking means that you are obliged to use the loan amount to buy a car. So you can’t buy anything else with it. In case you are extremely short of cash for some urgent expenses, you can pawn car titles to get some instant cash. A lot of financial institutions allow you to pawn car titles and clearly explain how to pawn your car title.
Why do you get better interest rates with car loans?
Because the car represents an equivalent value and thus increases your creditworthiness. The car serves as security for the bank, because in an emergency it can be sold and turned into money. That is why banks are more generous with the interest rate and in most cases make the car loan a cheaper alternative to dealer financing.
Things to keep in mind before taking a car loan
Regardless of whether you opt for dealer financing or a car loan from an independent bank: Both types of credit are similar in their basic features, because both are consumer loans. Therefore, the following tips apply equally to both: There are certain contract contents that you should take a closer look at.
Possible processing fees
Check this point carefully. In particular, in the case of installment loans, no costs for bureaucratic expenses such as checking the creditworthiness may be passed on to the customer.
Free full repayment
Some car loans allow partial repayment of the loan, but not all of it. In this case, an early sale of the car can be difficult. So make sure that free total repayments are included in the loan offer.
By the time you take out the loan, you are doing well financially and have thought about how much you can afford. Nevertheless, unforeseen events can lead to financial bottlenecks. Then you benefit from the opportunity to take installment breaks: In this way you can temporarily suspend the loan without having to fear further consequences. If this option is not available, you will quickly get into trouble in such situations.
Residual debt insurance superfluous
If the borrower is unable to repay the loan himself in the event of illness, disability or death, the residual debt insurance takes effect. It makes financing more expensive and is often not necessary in the case of a car loan because other insurance policies such as disability or term life insurance already cover these risks. It is therefore important to consider the relationship between the amount of the loan, the term of the loan and the increase in costs due to the residual debt insurance. With short maturities and low loan amounts, it is usually unnecessary.
Provisions for prepayment penalties
The prepayment penalty must not be too high. If you can repay your loan faster than planned, you owe the bank a prepayment penalty in many cases, which absorbs the lost interest. According to the law, this may not be higher than a maximum of one percent of the remaining amount. This means that early replacement is still worthwhile in most cases.
Differences between a car loan and dealer financing
Financing the car directly from the dealer sounds practical at first. It saves you the extra trip to the bank, is quick and uncomplicated. With a car loan from an independent bank, on the other hand, you have to invest energy and get offers yourself. But this investment is worth it, because independent banks usually offer better lending rates. In the following, we would like to explain to you what constitutes a car loan from an independent bank and dealer financing.
A low interest rate results in a loan that is easier to repay. At first glance, the interest rates for dealer loans are usually good, but they are not automatically the best. Be particularly careful if the dealer gives you a supposed zero percent financing offer. That sounds extremely tempting at first. But the dealer certainly has nothing to give away. Therefore, they often add the credit costs that still arise to the vehicle price. Then the dealer loan is cheap, but the car is more expensive than necessary. Or this financing only applies under certain conditions, such as only within the framework of a certain down payment on the vehicle price. So not only compare the dealer’s loan offer with car loans from independent banks, but also compare the vehicle price and equipment of other dealers.
The banks of the car dealers often offer car loans, behind which a so-called balloon financing is hidden. With such loans, the monthly installments are usually unbeatably low, but you hardly repay anything. After a few years, a relatively high residual debt has to be financed, possibly at lower interest rates.
The residual value of the car and the remaining debt are then often no longer in an acceptable relationship. A common car loan offers better repayment rates. Before completing car financing, have a precise repayment plan handed to you and make sure that the remaining debt is not too high after the loan term has expired.
The best are still car loans that run for so long that there is no residual debt left. So you can be sure that the full loan amount will be repaid after the agreed term.
What is the main risk associated with using your vehicle’s equity?
As discussed in the intro, the biggest risk of using your vehicle’s equity is ending up with negative equity or upside down on the loan. All cars depreciate and if you choose a sum equal to the car’s value, your vehicle’s equity will diminish much quicker than you can pay the loan. This problem is exacerbated when your car is lost/stolen/totaled. Your car insurance firm won’t cover what loan amount is owed by you. It will only pay out based on the value of the car. If the loan amount happens to be higher than the car’s value, the extra has to come out of your pocket. People considering refinancing should look into Guaranteed Auto Protection (GAP) Coverage. It’s a great tool for closing the gap between the money owed by you and what the insurance company will cover. This is a great way for you to have more peace of mind when you use your vehicle’s equity to take a loan.