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While the most common option for financing a new car is an auto loan, it’s also possible to pay for your vehicle using a home equity loan. This approach, however, involves vastly different considerations than an auto loan. Here’s how to determine whether using a home equity loan to buy a car is the best option for you.
Should I use my home equity to buy a car?
Avoid buying a car using home equity, if possible.
With a home equity loan, your home is the collateral for the loan, which makes it a much riskier financing option. If you fall behind on repayment, the lender can foreclose, and you could lose your home.
Generally, it’s best to tap your home equity if you’re going to spend the funds on goals or projects that further your financial well-being, such as renovating your house or paying college tuition. Because cars don’t hold their value well over time, it doesn’t make sense to tie your home up with financing for one — you’d be repaying a loan on an item that won’t be worth much when all is said and done.
In addition, you might need to pay closing costs for the home equity loan, which can run you anywhere from 2 percent to 5 percent of what you borrow — an expense you wouldn’t be on the hook for with an auto loan.
Of course, this assumes you’re taking out a home equity loan for the sole purpose of buying a car. If you plan to use only some of the funds to purchase a car and the rest more prudently, it can still make sense to tap your equity. It all depends on your goals.
Differences between home equity loans and auto loans
While a car loan is secured by the car you purchase, a home equity loan is secured by your home. That means the lender can foreclose on your home if you can’t repay it, regardless of what you used the funds for (in this case, to buy a car).
The repayment terms are also very different: You could have as long as 30 years to repay a home equity loan, versus the typical two to five years associated with an auto loan. Depending on how much you borrow with the home equity loan, this longer timeline could mean you have much lower monthly payments compared to the payments on a five-year car loan.
Remember, however: A car is a depreciating asset. By the time you’re finished repaying a 30-year home equity loan, your car won’t be worth nearly as much as what you borrowed (and paid in interest) to get it. A new car loses 23.5 percent of its value after about one year and 60 percent in the first five years, according to Edmunds.
Lastly, if you’re hoping to save money on interest with a home equity loan, think again. While home equity loans did have lower interest rates compared to auto loans for some time, that trend has reversed. Now, many auto loan offers are lower or comparable to the rates on home equity products.
Pros of using a home equity loan to buy a car
There really isn’t an upside to taking out a home equity loan to buy a car, even more so now that interest rates are rising. The one benefit might be:
- Longer repayment term: Home equity loans are structured in such a way that you can repay the money over a much longer period of time. Most car loans last between two and five years; a home equity loan lasts between 10 and 30 years. If you only borrow the amount you need for the car, this longer timeline might translate to lower monthly payments, all other things being equal.
Cons of using a home equity loan to buy a car
There are many more risks than rewards when it comes to getting a home equity loan for a car:
- Decreased equity: By getting a home equity loan, you’re depleting some of your equity, which has serious implications. For one, you might end up needing that equity in an emergency. For another, you might find you’ve taken on too much between your first mortgage and the home equity loan. This could eat into your bottom line if you need or want to sell the home in the future.
- Foreclosure risk: If you can’t or don’t repay the home equity loan, you won’t lose the car, but you could lose your home — a much more important asset.
- No financial gain: A car loses value over time, so, with a decades-long home equity loan repayment schedule, you might be paying for an asset that isn’t worth much in the end. If your car is no longer useable, this could also put you in the unenviable position of repaying a home equity loan while financing a new vehicle.
- Closing costs: Some home equity loans come with upfront closing costs. If you can afford to pay these, you might be better off putting some (or all) of those funds toward a down payment on an auto loan instead.
It’s possible to use your home equity to take out a loan for a car, but it’s a risky move. With the interest rates on home equity loans creeping up, it might make more sense to compare auto loan offers first.