Learn when it makes sense to use home equity to finance a car purchase and key factors to weigh in your decision.
Finding the cash you need for significant expenses such as buying a car can be overwhelming. That’s where loans come into play.
Traditional auto loans are usually the best financing option when buying a car. That’s because with that option, you are not using your home, for instance, as collateral for the purchase. But if interest rates are more favorable for a home equity loan, it could be an alternative to consider when purchasing a car under the right circumstances.
This article will help you understand these financial tools and determine if they’re a good solution for your own personal situation. We’ll explore what these options are, as well as their pros and cons, and offer practical tips for making smart financial choices.
We’ll also review other ways to finance your vehicle and take you through the steps of applying for these loans, providing you with helpful knowledge to make a well-informed decision about using your home equity for major purchases like a car.
Buying a car is one of the biggest purchases many people will make. With new cars costing over $48,000 on average and used car prices also sky high, coming up with the cash to buy a car can be challenging. On top of that, auto loan interest rates have been rising, making financing more expensive.
Some buyers are considering tapping into their home equity as a way to get a cheaper loan to purchase a car. But is taking out a home equity loan or line of credit to buy a car a smart move? I explored the pros and cons so you can make an informed decision.
How a Home Equity Loan for a Car Works
Home equity refers to the portion of your home that you own free and clear of any mortgage. It’s calculated by taking the current market value of your home and subtracting the amount you still owe on your mortgage.
You can leverage your equity to get cash by taking out a home equity loan or home equity line of credit (HELOC) Here are the key differences
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Home Equity Loan With this type of loan, you receive the money in one lump sum that you repay with fixed monthly payments over a set repayment term, usually 5-30 years The interest rate is also fixed
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HELOC: This functions like a credit card. You have access to a line of credit up to a certain limit and can draw money as needed. You only pay interest on what you actually use. The rates are variable.
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Cash-Out Refinance: You take out a new mortgage loan that’s bigger than your current balance, pay off your existing mortgage, and keep the extra cash. You get a lump sum at closing and make fixed monthly payments over a repayment term like a typical mortgage.
No matter which option you choose, your home serves as collateral on the loan. Defaulting could put you at risk of foreclosure.
Weighing the Pros and Cons of Using Home Equity for a Car
Below I’ve outlined some of the key benefits and drawbacks of tapping into your home equity to purchase a vehicle:
Potential Advantages
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Lower interest rate: Historically home equity loans and lines of credit have had lower interest rates compared to auto loans. However, this gap has narrowed recently as home loan rates rise.
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Tax deductible interest: You may be able to deduct the interest on a home equity loan or HELOC on your taxes if you use the money for home improvements. Interest on a car loan is not deductible.
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Consolidate debt: If you have high-interest credit card balances, you may be able to roll them into a home equity loan or HELOC at a lower rate.
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Access cash: For big expenses like a car, a home equity line can provide funds if you don’t have cash on hand or don’t want to liquidate investments.
Potential Disadvantages
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Risk losing your home: If you default on a home equity loan, your lender can foreclose on your home. With an auto loan, you just lose the car.
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Closing costs: You’ll pay 2-5% of the loan amount in upfront fees for a home equity loan, more than a car loan.
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Interest builds over time: The longer repayment term of a home equity loan or HELOC vs a car loan means you pay more interest over the life of the loan.
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Rates may adjust: HELOC rates can fluctuate so your monthly payments could go up over time.
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Cars depreciate: A car goes down in value rapidly, while home values tend to appreciate over time. Using an asset that gains value to purchase one that loses value carries risk.
As you can see, there are reasonable arguments on both sides. You have to look at your unique financial situation and determine if the benefits outweigh the risks.
Who Should (and Should Not) Use Home Equity to Buy a Car
While there are some cases where a home equity loan for a car purchase could be beneficial, most experts recommend against it. Here are some guiding principles on who should or should not head down this path:
When a Home Equity Car Loan Might Make Sense
- You have significant equity built up (at least 20% recommended)
- You need a car and have no other option to purchase one (e.g. no savings, poor credit score disqualifies other financing)
- You lock in a fixed interest rate lower than current auto loan rates
- You have a stable income and are very confident you can make the payments
- You have a plan to pay off the loan quickly, within 3 years
When to Avoid a Home Equity Car Loan
- You have minimal equity and are at risk of ending up underwater on your mortgage
- You can qualify for other financing at a reasonable rate
- You want the car as a luxury, not a necessity
- You are already stretched thin financially and adding another monthly payment would be a burden
- You plan to move within the next 3-5 years and won’t pay off the loan before selling
As a rule of thumb, if you have any doubts about taking on the added risk, you are probably better off not using your home equity to finance a car purchase.
What to Look For in a Home Equity Lender
If you decide to take out a home equity loan or HELOC to fund a car purchase, make sure to shop around lenders thoroughly. Here are some tips on what to look for:
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Low interest rates: Compare rates across multiple lenders, including banks, credit unions, and online lenders. Ask if they offer rate discounts for existing customers.
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Low fees: Closing costs, application fees, and origination charges can vary widely. Aim for total costs under 3% of the loan amount if possible.
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Flexible terms: Look for terms that align with how long you expect to keep the car and how quickly you plan to repay the loan. Ask about early payoff penalties.
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Fixed interest rates: A fixed rate eliminates surprises and prevents your monthly payment from going up. HELOCs usually have variable rates.
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Strong customer service: You want to choose an accessible lender who can guide you through the process and address any issues promptly. Read customer reviews.
Take the time to evaluate multiple lenders carefully based on these criteria before committing to a home equity loan.
Step-by-Step Process for Getting a Home Equity Car Loan
If you decide that leveraging your home to purchase a car makes sense for your situation, here is an overview of the process:
1. Check your home equity. Request an appraisal to confirm how much equity you have available. Lenders typically limit lending to 85% of your total equity.
2. Review loan options. Decide whether a home equity loan, HELOC, or cash-out refinance best suits your needs. Factor in costs, repayment timeline, rates, etc.
3. Check rates and apply. Compare offers from at least 3 lenders. When you apply, you’ll need to provide financial docs including your income, assets, debts, and credit history.
4. Get an approval. The lender will appraise your home and process your application. You could get approved in as fast as 1-2 days.
5. Finalize loan terms. Pick the offer that gives you the best rates and terms for your situation. Work with the lender to close on the loan.
6. Receive the funds. Once closed, the lender will either deposit the money in your bank account, mail a check, or give you a credit line to start using.
7. Shop for a car. With financing secured, you can focus on finding the right vehicle for your needs and budget.
8. Make payments. The lender will provide a repayment schedule. Be sure to make monthly payments on time to avoid putting your home at risk.
Be sure to carefully weigh the pros and cons before using home equity to finance a car. While there are some situations where it could be helpful, it also comes with considerable risk. Thoroughly evaluate your options to make the best decision for your situation.
Benefits of Using Home Equity for a Car Purchase
- Competitive rates: There is potential for lower interest rates. Home equity loans could offer lower interest rates, depending on the market, compared to traditional car loans. You could save money on interest over the life of the loan, resulting in lower monthly payments.
- Fixed monthly payments: Home equity loans often come with fixed monthly payments, making budgeting for your car expenses easier. With a fixed rate, you won’t have to worry about fluctuations in your monthly payment amount.
- Longer repayment terms: Home equity loans can offer longer repayment terms, typically ranging from five to 20 years. This can make your car purchase more affordable by spreading out the loan payments over a more extended period.
Auto Loans vs Home Equity Loans
Just as with a home equity loan, an auto loan is a secured loan. The difference is what is the collateral for the loan, your home or your car.
Auto loans traditionally have a fixed rate, but do have flexibility in terms of length of repayment. The monthly payment also takes into account your creditworthiness and down payment. Improving your credit score and having a good down payment will help lower your rates and therefore your monthly payment. You can receive auto loan rates either directly from a dealership or through a bank or other traditional lenders.
Perhaps the most important factor is that a car is a depreciating asset, meaning the value decreases over time. Home equity loans are best used for either debt consolidation or home renovation projects – acts that appreciate either your buying power or the value of your home.
Should you purchase a car with a HELOC?
Should you buy a car with a home equity loan?
You could have more leverage at the car dealership and could get a better deal on your car’s price. Potentially higher interest rates : Rates on a home equity loan could be higher than a new-car or used-car loan you could get from a credit union or bank.
Can a home equity loan pay off car debt?
Before deciding to use a home equity loan to pay off car debt, make sure you’ve considered these factors. 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.
Are car loan rates lower than home equity rates?
Now, many auto loan offers are lower or comparable to the rates on home equity products: As of May 2024, new car loan rates (starting as low as 5.64 percent) were averaging several percentage points lower than home equity rates (starting at 7.67 percent). Of course, these are averages.
Should you refinance a car or a home equity loan?
Potentially higher interest rates : Rates on a home equity loan could be higher than a new-car or used-car loan you could get from a credit union or bank. Repayment period outlasts ownership and depreciation: A cash-out refinance often lasts decades, so you’ll spend more on interest charges over time.