As with most other things in life, using a home equity line of credit to buy a car has its positives and negatives. It may be something you’re considering, but is using a home equity loan to buy a car the best option for you? To answer that question, 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 current rates on auto loans average between 5.01% to 6.38% for buyers with good credit, while home equity loan rates currently run from about 5.00% to 5.40% for people with above-average credit. The terms of these two loans are vastly different, though, so it’s not as simple as choosing the loan with the lower rate.
How to use a home equity loan to buy a car
Taking out a home equity loan to buy a car is a fairly simple process. You can contact a lender in person, by phone or through the lender’s website to find out about the approval process. You’ll need to have enough equity in your home — meaning that your house needs to be worth more than the amount left on your mortgage — and the process usually involves a credit check, home appraisal, loan application fee and supporting documentation. Once the required documents have been submitted and you are approved, you can usually expect to receive funding in less than two weeks.
Home equity loans vs. auto loans
When comparing home equity loans to auto loans, you should start by asking a few questions. Is a home equity loan better for my situation than a car loan? What circumstances might affect which type of loan I should choose? Should I use my home equity to buy a car? The answers lie in the key differences between a home equity loan and an auto loan.
The biggest difference between these two types of 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, and the payment terms are also different.
Advantages of using a home equity loan to buy a car
When you use a home equity loan to pay off a loan, you have the flexibility to cut down on or extend the time it takes to pay off the 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. With a home equity loan, the choice if you decide you want to pay the loan off early, but that’s not an option with a traditional car loan. You’ll have to pay that off in accordance with the terms of your loan or face stiff penalties, including having your car repossessed.
Lower interest payments
With a home equity loan, you can opt to make interest payments only on the amount you have borrowed for a set amount of years. This can lower the payment and reduce stress on your cash flow during tight times, but it can also cause issues when it’s time to pay back the principal on your loan. Luckily, you can always pay down your home equity loan faster if you have the funds, which will reduce the total amount of interest you pay on the loan.
Home equity loans may also help you save money on your taxes, since the interest paid on your loan is generally tax-deductible. The interest on your auto loan, on the other hand, is not. Keep in mind that the deduction will only make a difference if you itemize deductions on your tax return. If you take the standard deduction, the tax advantage no longer applies.
Disadvantages of using a home equity loan to buy a car
Variable interest rates
Home equity loans often carry a variable interest rate that may increase as time goes on. Be aware of this caveat and budget for a potential rate increase so you’re not stuck with snowballing interest payments that become unmanageable.
Longer payment terms
The flexibility with home equity loan payment terms can be a double-edged sword. You can delay paying on the principal by just paying interest for the first half of the loan, but if you don’t aggressively pay down the amount you borrowed, the loan could outlive your car. This could result in you still paying on 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, which could 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. Being upside down in a car loan is uncomfortable, but the situation becomes much more serious when you’re upside down on a home loan.
The bottom line
Can you use your home equity to take out a loan for a car? Absolutely, and you may get a better interest rate on your loan by taking that route. Before you move forward, though, be sure to determine the current market value of your home and whether it would sell for enough money to pay off your mortgage and your home equity loan. Make sure to also consider is how stable the housing market is in your area before you take the home equity loan leap. Know the terms of the loan, don’t overleverage yourself and don’t carry debt any longer than you have to.