Should you use a home equity loan to pay off vehicle debt?

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, they can be risky to use to retire a car 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, here are all the considerations, and how to tell if an alternative would be better.

Should I use a home equity loan to pay off my vehicle debt?

Can you use a home equity loan to pay off your car? Well, sure. You can use a home equity loan for almost anything. But while it is possible to use a home equity loan to pay off your vehicle debt, it is generally not advisable to do so.

While a few one-year options exist, home equity loans are generally long-term debt, with terms that can extend for decades. 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. It could be in danger if you are unable to repay what you owe.

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 terms range from 5 to 30 years while car loan term lengths range from 2 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 6 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 your equity stake — the portion of the home you own outright. If the amount you owe on that loan, your mortgage and any other home loans is more than your house is worth, you could become upside down on your mortgage. That could hamper your ability to sell your home.
• 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.

Considerations when paying off a car loan with a home equity loan

Before deciding to use a home equity loan to pay off car debt, make sure you’ve considered these factors.

Fixed vs variable interest rates

Home equity loans and auto loans have fixed interest rates, but if you choose a home equity line of credit (HELOC), it will probably have a variable rate. Your HELOC interest rate can increase or decrease depending on the market. When your rate rises, you’ll end up paying more interest, making payments unexpectedly heavy.

How the debt can impact your home

When you take out a home equity loan, your house serves as collateral – meaning that if you can’t pay back your loan, you could lose your home.

Fees

Home equity loans and HELOCs may come with certain fees, such as an origination or appraisal fee, as well as other closing costs (just like a mortgage). You might also face a prepayment penalty for repaying your loan or HELOC early.

Alternative ways to pay off your vehicle debt

Given all of the risks associated with using a home equity loan to pay off an auto loan, 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 auto loan: If you’ve had the car and the car loan for several years, you may qualify for lower interest rates, 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 auto 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 if you’re even a little bit concerned that you can’t repay your loan, then combining your car loan with your mortgage, adding to your overall home-related debt burden, isn’t a great option. Plus, the constantly depreciating value of the vehicle could make it not worth it to take out a 5- to 30-year loan.

However, a set of wheels is a necessity for many people, almost as vital as a roof over their heads. 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 you’d like to work with.