If you’re looking to buy a car, the traditional choice for financing is an auto loan, but it’s also possible to finance your vehicle using a home equity loan. To determine if using a home equity loan to buy a car is the best option for you, you need to know how to use a home equity loan for car purchases and when a home equity loan might be a better solution than a standard auto loan. The terms of these two loans are vastly different, so it’s not as simple as choosing the loan with the lower rate.
Should I use my home equity to buy a car?
Buying a car using home equity is a high-risk financing option that should be avoided if possible. Since your home is used as collateral for a home equity loan, the lender can foreclose on it if you can’t repay the loan.
Also, consider that a car’s true market value depreciates at an accelerated rate. According to Edmunds, a new car loses an average of 11 percent of its value once it leaves the lot. After five years, a car’s true market value averages only 37 percent of what the buyer paid at the dealership.
If you buy a car using a home equity loan, which can offer repayment terms as long as 30 years, you’ll be paying for a vehicle that’s not even worth that loan amount anymore.
Pros and cons to using a home equity loan to buy a car
Although a home equity loan is one option to buy a car, there are several factors to consider before going this route. Here are some of the biggest benefits and drawbacks of buying a car using a home equity loan.
Most car loans are for a set duration of three to seven years, but a home equity loan typically gives you a longer period to repay, generally between 10 and 15 years and sometimes longer. With a home equity loan, you can also typically pay the loan off early, which is not the case with many auto loans.
Lower interest payments
Home equity loans typically have lower interest rates than auto loans, which could help if your budget is tight. If you have good credit, you may be able to find home equity loans with rates as low as 3 percent.
Longer repayment terms
The longer repayment timeline of a home equity loan will lower your monthly payments, but the loan may also outlive your car. This could result in you still paying your home equity loan for the old vehicle while financing a new vehicle.
Decreased home equity
Using your home equity to finance a car decreases the total amount of equity you have available in your home. This can be a problem if you need to sell your home before you’ve paid the loan back. That could cause you to become upside down on your mortgage if your home value decreases to the point that you owe more on your mortgage and the home equity loan than your house is worth.
Some home equity loans incur up-front closing costs in addition to the interest you’ll pay over the loan term. This means that even if you get a lower interest rate than you would with an auto loan, a home equity loan could cost you more money.
Risk of foreclosure
If you’re unable to keep up with payments, the lender can sell your home to recoup the debt that you owe.
Home equity loans vs. auto loans
The biggest difference between home equity loans and auto loans is that while a traditional car loan is secured by the car you purchase, a home equity loan is secured by your home. The interest rates are generally different, as are the payment terms.
Typically, home equity loans have longer repayment terms and lower interest rates than auto loans, meaning your monthly payment will be lower. However, a longer repayment period will mean that you pay more in interest overall, and you may not want to be stuck with a loan for 10 or 20 years, especially if you switch cars often.
The bottom line
It is possible to use your home equity to take out a loan for a car, and you may get a better interest rate on your loan by taking that route. However, before you move forward, consider the risks of using your home as collateral and the drawbacks of choosing a longer loan. You may not want to carry debt any longer than you have to, especially for a car.