When talking about auto loans, you may have heard the word “equity” used. But what does it mean? Equity is the difference between the value of the vehicle and the amount owed on the loan. For example, if your car is worth $10,000 and you have an auto loan balance of $4,000, you have $6,000 in equity. If you pay off the loan, you will have $10,000 in equity because you no longer owe money on the car.
It is also possible to have negative equity – meaning you owe more money than the car is worth. This is sometimes referred to as being “upside down” on the loan.
Ways to use equity
Some financial institutions allow you to use the equity in your vehicle when offering a loan. You would get an auto loan for the value of the vehicle and use the money for another expense. In some cases, this can be helpful because auto loans typically have much lower interest rates than other types of loans or credit cards. For example, if your laptop broke and you did not have the cash to replace it, you might be able to use the vehicle equity instead of a card to pay for the new laptop. Equity also can be a good option to consider for paying down other debts, such as credit card balances or student loans, because of the lower interest rates.
To use your vehicle equity, you would need to refinance the vehicle. If you have an existing auto loan, you would work with your financial institution to apply for a new auto loan. If approved, your existing auto loan would be paid off and the equity would be deposited to your account. Using the previous example, if you were approved for the full value of the car ($10,000) the existing loan of $4,000 would be paid off and you would have $6,000 to use as needed. If you do not have a loan on the vehicle, you may be able to finance the full value of the vehicle.
Mind the GAP
The main risk with using your vehicle’s equity is ending up upside down on the loan. Because vehicles lose their value, if you were to borrow as much as the vehicle is worth, the equity may decrease faster than you can pay off the loan. This can be a problem if the vehicle is lost or totaled because auto insurers typically cover only the value of the car, not what is owed. If the loan is more than the value, you are responsible for paying off the rest of the loan. If you are considering refinancing, talk to your financial institution about Guaranteed Auto Protection (GAP) Insurance. This covers the “gap” between what the insurance company will cover and what you owe. Having GAP Insurance could save you a lot of money and offer peace of mind.