Pros and Cons of Consolidating Car Loans To Save Money

If the cost of your monthly bills feels like too much, you may consider consolidating debt. But what if you have secured debt like auto loans, is it still possible?

The good news is that there are several ways to combine debts to potentially get a lower monthly payment or save on interest. In some cases, you can even consolidate car loans. Here’s what you must know.

Can you consolidate car loans?

Yes, there are ways to consolidate your car loans and other consumer debt into a single loan. I encourage you to explore all of your options, including using your home’s equity to consolidate loans and using a personal loan to consolidate consumer debt.

Reasons you may want to consolidate car loans

• You have more than one car payment with different due dates and want to simplify your monthly payments
• Your current interest rate is high and you qualify for a lower one
• Your current monthly payment is high and you qualify for a lower one
• You need fewer payments to avoid missed payments to boost your credit score

As with all debt consolidation options, there are benefits and drawbacks to consider. Here are the pros and cons of your main options to help you decide.

Ways to consolidate car loans

Consolidating car loans with a home equity loan

If you own your home and have significant equity in it, you can use a home equity loan to pay off your existing car loans. You can get a home equity loan from your existing mortgage lender or through a different one.

What is a home equity loan? A home equity loan is a loan against your house. It usually takes a second lien position after your first mortgage and you can use it for almost any purpose, including consolidating debt. However, like any loan, there are downsides to consider.

Pros

You eliminate the liens on your vehicles. Since the collateral on a home equity loan is your house, your cars are no longer collateral. You can do what you want with the vehicle, including sell it without worrying about any liens.

It may reduce your auto insurance requirements. Auto lenders typically require certain levels of insurance on your car to protect their collateral. Once you own the car free and clear, however, you just need to make sure you comply with state minimums.

Of course, it’s still a good idea to have sufficient coverage in case you need it. But you’ll have more flexibility over what you choose and can save money on your monthly premiums.

You can combine your car loans with other loans. Mortgage lenders typically don’t restrict how you use your loan funds. If you have car loans, credit card balances, and other debts, you may be able to combine all of them into one loan to simplify things and pay off your debt faster.

Cons

You could lose your home. Just as you can lose your car if you default on an auto loan, a mortgage lender can foreclose on your house if you stop paying your home equity loan. Since losing your home is usually worse than losing your car, you increase your risk using your home equity.

Closing costs can be expensive. Closing costs on a home equity loan average between 2% and 5% of your loan amount. If you’re consolidating $30,000 worth of car loans, for instance, you can expect to pay $600 to $1,500 up front. I suggest comparing the cost to the overall savings to ensure the consolidation makes sense.

You may not have enough equity. Most mortgage lenders limit how much you can borrow using a home equity loan. Most lenders require you to keep at least 20% equity between your primary mortgage and any equity loans, so for every $100,000 your home is worth, you need to leave at least $20,000 untouched.

If you don’t have a lot of equity, you may not qualify for a big enough loan, if at all.

Consolidating car loans with a personal loan

As long as your credit and income are in good shape, you may have a good chance of getting a good interest rate on a personal loan. Like home equity loans, there are some considerations to keep in mind.

What is a personal loan? A personal loan is an unsecured loan, usually from a bank, credit union, or you can find them with online lenders. A personal loan doesn’t require collateral, such as your car or house, but you typically need credit credit and a low debt-to-income ratio to qualify.

Pros

It converts the auto loan to an unsecured debt. Personal loans are typically unsecured, which means you won’t lose your car or your home if you default. There will, however, be credit and financial consequences if you stop making payments. They just might not be as bad as losing shelter or transportation.

It reduces your car insurance requirements. As with a home equity loan, a personal loan eliminates the need to use your cars as collateral. Without a lender setting minimum requirements for your car insurance policies, you get more flexibility with your coverage.

Cons

Your chances of getting a lower interest rate are low. There are several factors that go into debt consolidation loan rates but typically, secured loans offer lower interest rates than unsecured loans because the collateral reduces the lender’s risk. This could make it more challenging to score a lower interest rate on a personal loan than you might get on a home equity loan.

You could get a shorter repayment period. In general, personal loans tend to offer shorter repayment periods than car loans. Where a repayment period of five, six, or even seven years is standard with auto loans, personal loans tend to max out at seven years.

A shorter repayment period could increase how much you pay each month, even if you get a lower interest rate.

For example, let’s say you have a five-year auto loan of $20,000 with an interest rate of 18%. Your monthly payment would be $507.87. If you replace that with a consolidation loan with a 12% interest rate and a three-year repayment term, your payment will jump to $664.29.

I suggest you look at the big picture. The shorter-term and lower interest rate will cost you less in the long run, but you must make sure you can comfortably afford the new payment.

How consolidating car loans affects your credit

In general, consolidating car loans using any of these options won’t have a big impact on your credit. While you’ll likely get a hard inquiry for applying for the new loan, that generally takes less than five points off your FICO credit score.

If you consolidate car loans without adding more debt to the mix, your amounts owed won’t change. Even if you take on more debt, it likely won’t change much unless it increases your debt-to-income ratio too much.

Refinancing could be a better option

Consolidating car loans combines multiple car loans and possibly other consumer debt to reduce your payment or interest rate, but you also have the option to refinance your car loan. If you have multiple car loans, you must refinance each loan separately.

I like refinancing car loans because you can try to get a lower interest rate or better loan term. It’s also helpful if you can’t afford your current payments and need a longer term, although that’s not ideal because you’ll pay more in interest.

You can refinance your auto loan with your existing lender or find a new lender that offers better rates or terms.

What happens if you have bad credit?

If your credit hasn’t improved since you first took out your loans or you have a lower score now, you may have limited debt consolidation options. While many lenders specialize in helping people get out of debt with bad credit, their interest rates can be high, which could end up costing you more in the end.

Fortunately, there are a few options:

• Find a cosigner: Adding someone with good credit to the loan application decreases the lender’s risk, which could result in a lower interest rate.
• Make a down payment: If you have some cash saved that you can put toward the car loan, you pay down the amount you borrow, which reduces the lender’s risk, and may increase your chances of approval.

FAQ

Bottom Line

Consolidating car loans can get complicated if you’re not careful, though, so it’s important to understand your options before you make any decisions. In addition to considering ways to consolidate car loans into one new one, also think about refinancing them separately. Depending on the situation, doing that could prove simpler than trying to combine them.

Whatever you do, make sure you understand the costs of the options, and compare them to what you currently pay. The best option will almost always be the one that keeps more money in your wallet.