If you are struggling to make your car payments and have equity built up in your home, you may be tempted to use a home equity loan to pay off your vehicle. While home equity loans do typically come with more flexible terms and lower interest payments than auto loans, it can be risky to use this type of loan for vehicle debt.
Some risks include decreased home equity, high closing costs and potential foreclosure if you don’t pay off the loan. Longer repayment terms could also mean you end up paying off the loan past the life of your car.
If you are already struggling with your car payments, adding another loan could send you further into debt in the long run. Before using a home equity loan to make your car payments, evaluate if this is the right choice or if an alternative would be better.
Should I use a home equity loan to pay off my vehicle debt?
While you can use a home equity loan to pay off your vehicle debt, it is generally not advisable.
Home equity loans have terms generally ranging from five to 30 years. A car’s market value begins depreciating the moment it leaves the lot, meaning you could pay way more than your car is worth by the time you finish paying off the home equity loan.
You must also consider that when you take out a home equity loan, you are putting your home up as collateral in case you are unable to repay what you owe. Your home could end up in foreclosure if you do not pay back the loan.
Benefits of using a home equity loan to pay off vehicle debt
- Flexible terms: Home equity loans generally have more flexible loan terms than auto loans. Home equity loan term lengths range from 5 to 30 years while car loan term lengths range from 3 to 7 years.
- Lower interest payments: Home equity loan interest rates tend to be less than auto loan interest rates, and if you have good credit you may qualify for rates as low as 3 percent.
Risks of using a home equity loan to pay off vehicle debt
- Loss of home equity: When you use your home equity to secure a loan, it decreases the total amount of equity you have available in your home. If you have not paid off the loan by the time you sell your house and the amount you owe on that loan, your mortgage and any other home loans are more than your house is worth, you could go upside down on your mortgage.
- Closing costs: Some lenders charge upfront closing costs ranging from 2 percent to 5 percent of the loan amount. These charges combined with interest could have you paying more, despite lower interest rates.
- Longer repayment terms: Even though having a longer repayment term lowers your monthly payments, it also means that your loan could outlive your car. You could even end up paying off the loan for the old car while trying to finance the new one.
- Risk of foreclosure: If you are unable to make your monthly payments and get too behind on the debt, the lender can sell your home in order to recover the money you owe.
Alternative ways to pay off your vehicle debt
Given all of the risks associated with using a home equity loan to pay off auto loan debt, it is generally best to try other options before tapping into your home equity. If you can’t make your monthly payments, you can try refinancing your loan, renegotiating, or selling your vehicle.
- Refinance your loan: You may qualify for lower interest rates in refinancing, especially if your credit score has improved since you initially financed your vehicle. Refinancing does, however, come with fees that borrowers should be wary of.
- Renegotiate the loan: Lenders are often willing to renegotiate loans, particularly if you have good credit history and only need short-term assistance. Getting a payment deferred or stretching out the loan term could give you the time you need to get your payment together.
- Sell the vehicle: If you ultimately decide you can’t afford the car, you can sell it with the lender’s permission or trade it in with the dealership with which you’re financing. You will still be on the hook for the balance you owe, but it could relieve some of the financial burden.
The bottom line
Cash-strapped homeowners falling behind on their car payments might look to home equity loans as a solution. The flexible terms and lower interest rates are appealing. However, using home equity as collateral is always risky, and the constantly depreciating value of the vehicle could make it not worth it to take out a 5- to 30-year loan.
However, transportation is a necessity. Many can not afford to lose or sell their vehicle. If you feel that taking out a home equity loan to pay off your vehicle debt is the right choice for you, research the best home equity loan rates and choose a lender that fits your needs.