 Use
home equity loan to buy car
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 Dear
Dr. Don,
I own a condo and paid cash for it. Its value has tripled. If I
need to finance a new car, should I apply for home equity loan or
a home equity line of credit? Is the interest expense tax deductible
on both types of loans?
Thank you for your help.
-- Nicole Nicety
 Dear
Nicole,
Congrats on the nice return on your condo investment.
Tapping the condo's equity to finance a car purchase makes perfect
sense -- if you're fairly disciplined with your finances.
A home equity loan is at a fixed
interest rate, for a fixed loan term, with a self-amortizing loan
payment; meaning that the monthly payment covers both the interest
expense and the paying down of the principal balance. It's the classic
choice for borrowing against your home's equity for a specific purpose,
in your case financing a car.
In contrast, the home equity line of credit, or HELOC,
is a variable-rate loan that typically has interest-only payments,
at least in the early years of the loan. The interest rate is generally
priced at a spread to the prime interest rate, which is currently
6.75 percent. You can track the prime interest rate on Bankrate
using Rate Watch.
The prime rate has been moving in lockstep with changes in the Federal
Reserve Board's targeted Federal Funds rate, and the Fed isn't done
with its current cycle of raising this short-term rate. As I write
this reply, Bankrate's national average for a home equity loan is
7.21 percent and 6.84 percent for a HELOC.
The interest expense on a home equity loan or HELOC
may be a tax-deductible expense but isn't always one. IRS
Publication 936, Home Mortgage Interest Deduction, explains
the limit on home equity debt. Talk to your tax professional if
you're uncertain whether you can deduct the interest expense. Even
if you aren't eligible for the deduction, the interest rate on the
home equity loan is less than the current national average of 8.06
percent for a 48-month auto loan.
One advantage of
the HELOC is that you can pay down the principal balance and then, at least in
the early years of the loan, borrow that money again. Having an available balance
on a home equity line of credit can substitute for emergency fund savings. If
you don't have much flexibility in your finances, having an available balance
on the HELOC can be important.
Since you don't have a first mortgage on the
property, assuming you have a good credit score, you should be able
to get a lender's best rate on a home equity loan or HELOC. Home
equity financing is typically a second mortgage on the property
and has a higher interest rate because of that standing. You don't
have a first mortgage, so the home equity lender is first in line
in foreclosure. That improved standing should translate into a lower
rate on the loan. It won't be a lot, but you should see a difference
between your rate and the advertised rate for the loan.
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