Dear Dr. Don,
My husband thinks that taking out a home equity loan for car is a wiser thing to do than getting a car loan. I beg to differ!
Roughly five years ago, I bought a brand new Altima from my credit union at 4.9 percent interest. It was a five-year loan that I managed to pay off in four years. I know a home loan is tax-deductible, but in the long run is it better than simply taking out a car loan with a much better interest rate?
Even more troubling, what if we buy the car with a home equity loan and realize we can't pay the loan back?
-- Certain Cheryl
Dear Cheryl,
Although in general I agree with your husband, you've gotten down to the crux of the matter. You're better off with the auto loan if you can get a better rate from your credit union on an auto loan than the effective rate of interest on the home equity line or home equity loan. You may have gotten a lower rate with your credit union loan, making it the better decision for you.
A while back, I worked with The Washington Post's nationally syndicated columnist Michelle Singletary on a calculator that compared the different types of loan options to estimate which loan would give you the lowest total interest cost on an after-tax basis. The "What's the best way to finance a car purchase?" calculator is still available on Bankrate.
When getting a low rate from a dealer, you'll want to compare the loan against any rebate offered in lieu of the low-interest financing. Bankrate's auto loan calculator, "Which is better: a rebate or special dealer financing?" can help with that decision.
The current Bankrate Interest Rate Roundup has the national average for a five-year auto loan at 6.83 percent. The national average for a home equity line of credit is 5.56 percent, and a home equity loan is 8.04 percent. So a HELOC easily trumps the auto loan. The home equity loan can, too, on an effective rate basis.
If you can afford to pay the auto loan back, you can afford to pay the same amount back on a home equity line or loan. A lower interest rate and a longer term make those payments more affordable. One big advantage to the car loan is that you're not betting the house with the risk of foreclosure. Instead, you're just betting the car -- with the risk of repossession.
Read more Dr. Don columns for additional personal finance advice.
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