Should You Pay Off a Car Loan With a Cash-Out Refinance?
With a cash-out refinance, you can convert some of your home’s built-up equity into cash. The funds from the refinance are yours to use however you see fit.
Borrowers often use their cash-out to consolidate other debts – including car loans. Especially today, when it's not uncommon for people to have monthly auto payments above $1,000.
But is it a good idea to pay off an auto loan with a cash-out refinance mortgage? In most cases, no. But there are some situations where it might make sense to wrap your monthly car payment into your home’s mortgage.
Why You May Want to Pay Off a Car Loan With a Cash-Out Refinance
There are two primary reasons why people consider paying off a car loan with a cash-out refinance:
Reduce monthly payments
Lower their auto loan interest rate
It could make sense to consolidate a car loan if you have a high rate – say in the 7s – or a even refinancing “up” into a higher rate – say form the 3s to the 6s.
We’ll look at both scenarios.
Refinancing a Car Loan If You Have a High Mortgage Rate Now
If you've purchased your home and vehicle within the past couple of years and are locked into higher interest rates, you will probably see a noticeable drop in monthly payments.
For Example: Your current 30-year mortgage is for $280,000 at 7.5% and a $30,000 72-month car loan at 8.5% interest
How could a 30-year no-cash refinance on your $280,000 balance at 6.0% affect your payments? What about combining both loans into a $310,000 30-year cash-out refinance at 6.5%?
Current Mortgage Payment (7.5%) | $2,100 |
Current Car Payment (8.5%) | $620 |
Total House + Car Payments | $2,720 |
Refinance (6.5%) With Car Payment | $1,960 |
In this scenario, your current payments would total $2,720. By combining the two with a cash-out refinance, you'd be paying $1,960 per month, reducing monthly expenses by $760.
Cash-Out Refinance if You Have a Low Rate Now
What if you currently have a low mortgage rate? A cash-out refinance might still make sense, depending on your situation.
For Example: Your current 30-year mortgage balance is $240,000 at 3.5%. You're planning to buy a new truck and are considering taking a $60,000 72-month loan at 7.5% or wrapping it into a home refinance at 6.5%
How would taking out a new $300,000 30-year mortgage at a higher rate affect your payments?
Current Mortgage Payment | $1,350* |
Potential Car Payment | $1,040 |
Refinance (6.5%) With Car Payment | $1,900 |
In this example, wrapping the new car into your mortgage would save nearly $400 monthly, even though you’re refinancing to a higher interest rate.
But that’s not the end of the story. What about long-term costs?
The Downside: Long-Term Interest Costs
Though they come with higher rates, auto loans cost less overall because of their shorter term. The most common length for a car loan is 72 months, or six years.
When you finance the loan with your home mortgage, you spread the payments and interest over a more extended period. Even with lower rates, you wind up paying extra across the life of your loan.
For example, let's compare the interest paid on a $25,000 72-month car loan by itself, wrapped into a 15-year mortgage, and wrapped into a 30-year mortgage.
Loan Type | Estimated Interest Rate | Total Interest on $25,000 |
Auto Loan (72 months) | 7.5% | $6,000 |
15-Year Mortgage (180 months) | 6.0% | $13,000 |
30-Year Mortgage (360 months) | 6.5% | $32,000 |
Including your car loan into a 30-year mortgage will likely cost you more in interest than you originally borrowed. And you'll probably be paying on it for far longer than you own the vehicle.
Wrapping Your Car Loan Into Your Mortgage for a Lower Rate
What if cash flow isn't an issue, and you plan to continue making your regular monthly auto payment towards a combined mortgage? In that case, it may be tempting to use a cash-out refinance to lock in a lower rate.
This would let you quickly pay off the added principal, significantly reducing the interest cost.
But the biggest problem is that many people become lax with making additional payments, leading to a situation where they pay more interest than initially planned.
Plus, with separate home and car loans, your required monthly payments decrease once you pay off the automotive portion of your debt. When combined, your monthly minimum remains fixed for the life of the mortgage.
Other Downsides to Using a Cash-Out Refinance to Pay off Your Car
There’s more than just long-term interest costs to dissuade you from using a cash-out refinance to pay off your car. Here are a couple of other reasons that should cause hesitation.
Using Your Home as Collateral
Your auto loan is secured by your vehicle. If you fall behind on payments, the lender can repossess your car to cover their losses. There are situations where they may attempt to collect a deficiency balance. However, it's uncommon for this to escalate to a legal judgment for most consumers.
When you wrap your auto loan into your mortgage, you're effectively offering your property as collateral for your vehicle. If you miss mortgage payments due to the added burden, your lender could move to foreclose on your home.
Mortgage Closing Costs
Closing costs for a refinance often run between 2% and 4% of your total mortgage. If you’re cashing out a small amount – or already have a considerable mortgage balance – you might end up paying more in fees than it’s worth.
For example, if your current mortgage balance is $150,000 and you want to wrap in your $15,000 auto loan, you’d pay closing costs on the new total of $165,000. At an estimated 3%, this would be $4,950.
In this scenario, paying nearly $5,000 in closing costs to cover a $15,000 car loan probably wouldn't make sense.
But what if you wanted to cash out equity for a more expensive vehicle?
If your current mortgage balance is $150,000 and you want to wrap in your $50,000 auto loan, you'd pay closing costs on the new total of $200,000. At an estimated 3%, this would be $6,000.
Here, the closing costs are more reasonable relative to the car loan. Even still, you'd be paying 12% of the cash-out amount to combine the two payments.
Why You May Want to Pay off a Car Loan With a Cash-Out Refinance
Even though there are multiple downsides to paying off your car loan with a cash-out refinance, there are still some situations where borrowers may want to consider it.
You Expect Your Income to Grow in the Future
If cash flow is currently tight, but you can reasonably expect an increase in income shortly, it may make sense to wrap your auto loan in with your home mortgage. This could allow you to get by until you can shore up your finances.
Some situations where this might apply include a small business owner experiencing steady long-term income growth or when finishing up an advanced degree in your current field.
You Plan to Sell Your Home and Want to Reduce Monthly Payments
If you plan to sell your home in the next couple of years, it might make sense to wrap a high-interest auto loan with your mortgage to reduce your monthly debt obligation. The shorter time frame would limit additional interest paid. However, you'll also reduce your equity when it comes time to sell.
Qualifying for a Conventional Cash-Out Refinance
Having equity in your home doesn't necessarily qualify you for a cash-out refinance. First off, conventional lenders won't let you cash out all of your home's value. Your refinance is capped at 80% of the appraised value for single-unit primary residences. That limit is even lower for multi-unit houses, second homes, and investment properties.
And even though you may be able to cash out up to 80% of your home's value, you'll pay more in risk-based lending fees than if you leave additional equity. Refinancing to just 70% of your property’s value could save thousands of dollars in costs compared to cashing out the maximum.
Other Lender Requirements
On top of equity requirements, you must also meet conventional lending guidelines regarding your credit, income, and debt obligations. Lenders offering cash-out refinances require a minimum credit score of 620.
They also want you to have a debt-to-income (DTI) ratio of 45% or below. Your monthly obligations, including your mortgage, car payment, and other personal debt, should account for at most 45% of your qualifying income.
Related: Conventional Cash-Out Refinance Guidelines
Paying Off Debts at Closing to Qualify
You may already have a DTI above the conventional lending maximum if you're considering a cash-out refinance to help with cash flow.
Thankfully, guidelines allow lenders to exclude debts that will be paid off at closing. This also applies to installment debts, like car loans, which will have ten or fewer payments remaining.
If you're wrapping your car payment into your conventional mortgage, lenders may be able to qualify you based on your new, lower DTI.
What’s Going On in the Vehicle Market?
Vehicle costs have increased substantially over the past few years. Car buyers often pay more than $50,000 for a new vehicle, with many having monthly payments in excess of $1,000. That makes it easy to understand why some people might be interested in paying off their vehicle loan with a cash-out refinance.
High Vehicle Prices
Vehicle prices have seen a modest recent decline, but the cost of a new car remains near an all-time high. According to Kelley Blue Book data, the average was $48,247 in November 2023. For luxury vehicles, that figure rose to $62,235.
Another segment that's seen a notable price increase is pickup trucks. Cars.com recently reported that during August 2023, the average new truck cost more than $60,000. The figure jumps to $94,000 for electric pickups.
Rising Interest Rates
Interest rates have been rising across the board, especially for auto loans. According to Edmunds, the average APR for a new vehicle loan was 7.4% in November 2023. Five states had averages above 8%.
For used vehicle loans, the average APR was 11.6%. Fifteen states had a used average above 12%, peaking as high as 14.11% in Mississippi.
Massive Monthly Payments
Price increases coupled with rising interest rates can lead to sizable monthly payments. Edmunds found that during the second quarter of 2023, there were nine states where more than 20% of car buyers were paying at least $1,000 monthly.
That figure tops 25% in Texas and Wyoming, likely due to the high percentage of pickup trucks sold. In over half of the states, at least 15% of buyers were paying $1,000 per month or more.
Other Ways to Pay Off Your Vehicle Loan With Home Equity
A cash-out refinance isn't the only way to use your home's equity to pay off your car loan.
You may also want to consider a home equity loan, which allows you to borrow funds without altering your first mortgage. While rates for home equity loans are higher, you'll generally pay less in closing costs. This may be a savvy option for borrowers with a low-interest first mortgage.
Another alternative may be a home equity line of credit (HELOC). This option allows you to draw on your home's equity over time rather than all at once. This may be a good option if you have other planned expenses but are still determining exactly how much you'll need or when you’ll need it.
Plus, HELOC rates are often adjustable. This could equate to lower monthly payments if interest costs continue to fall.
Using a Cash-Out Refinance to Pay Off Your Car Loan
For most consumers, paying off a car loan with a cash-out refinance is not a wise idea. But everyone's financial situation is different, and there are some scenarios where it's the most practical option. Contact a qualified mortgage professional to determine how wrapping your auto loan into your mortgage could affect your monthly payments and long-term costs.
*Note: These are both basic estimates based on example rates and don't include variable factors like taxes, insurance, and closing costs. Talk with a lending professional for a more comprehensive idea of how a cash-out refinance may affect your payments.
