Should You Use a Home Equity Loan to Buy a Car?

When you need a new vehicle but don’t have much cash for a down payment tapping your home equity with a loan may seem tempting. Home equity loans often have lower rates and more flexible terms than auto loans. But is using your house as collateral to finance a car actually a smart move?

In most cases, the answer is no. There are significant risks and drawbacks to using home equity to purchase a depreciating asset like a car. However, there are some scenarios where it can make sense if done carefully.

In this article we’ll examine the pros and cons of using home equity to buy a car so you can weigh the options and make an informed decision.

Overview of Home Equity Loans

Before looking at the implications of buying a car, let’s review what home equity loans are and how they work.

A home equity loan leverages the equity built up in your home to borrow money at a fixed interest rate Your house serves as collateral on the loan

• Interest rates are typically lower than other financing options like credit cards or personal loans.

• Loan amounts can go up to 85% of your total home equity.

• Terms usually range from 5-30 years so monthly payments are lower.

• The funds can be used for any purpose – home improvements, debt consolidation, large purchases, etc.

While home equity borrowing is usually a smart financial move for renovations that boost property value, using it for depreciating assets like cars or boats is generally riskier.

The Potential Benefits of Using Home Equity

Given the typically lower interest rates and extended repayment terms compared to auto loans, it’s easy to see the temptation to tap home equity to buy a car. Some potential benefits include:

Lower monthly payments – Longer loan terms can mean more affordable monthly payments that fit your budget better.

Fixed interest rates – Home equity loans lock in a fixed rate compared to variable rate financing like HELOCs.

Consolidate existing car debt – Could allow you to fold an existing car loan into the new home equity loan at a lower rate.

Leverage home value – For owners with substantial equity, allows borrowing against that rather than requiring a down payment.

Potentially better terms – Depending on credit, home equity loan rates and qualifications may be more favorable than auto financing.

Access cash – Provides funds now rather than saving up to buy a car later.

The Cons of Using Home Equity for a Car

While potentially enticing, there are significant downsides to using home equity loans for a vehicle purchase:

Risks your home – If you default, the lender can foreclose on your home which is at risk as collateral.

Cars depreciate rapidly – The vehicle will lose significant value as you pay off the loan over years.

Loan outlasts car lifespan – Long repayment term means paying years after you’ve stopped driving the car.

Prepayment penalties – Home equity loans often charge fees for paying off early.

Closing costs – Upfront fees usually range from 2-5% of the loan amount.

Difficult to refinance – Refinancing with lender may not be possible if you sell the home before loan maturation.

Impacts home affordability – Existing mortgage + equity loan could limit how much you can borrow for next home.

Reduces equity – Large loans decrease the ownership stake available for emergencies or future borrowing needs.

Potentially postpones savings – Money that could have gone to retirement or child college savings is diverted.

Equity may earn better returns if invested – Interest paid on home equity loans may exceed earnings from investments.

The overall takeaway is that the flexibility and tempting terms of home equity loans for car purchases come with sizable risks and opportunity costs.

Situations When Using Home Equity Could Make Sense

While the drawbacks often outweigh the benefits for buying a car, some particular situations could potentially justify using home equity:

• You need a very large vehicle like a full-size SUV for a large family or work purposes.

• You require specialty features only available on higher end, expensive vehicles.

• You have business use of the vehicle that helps generate income.

• Your home value has increased substantially providing ample equity.

• Your credit score is poor and auto loan rates would be exorbitant.

• You’re consolidating other high rate debts like credit cards along with the car purchase.

• You have a very small remaining mortgage balance so the equity stake is not large.

The key is thoroughly evaluating your unique circumstances and determining whether potential benefits outweigh the risks and costs. Carefully crunch the numbers for both financing options.

And alternatives like saving up longer for a larger down payment on an auto loan, or purchasing a more affordable used car are worth considering before putting your home on the line. If home equity borrowing still makes the most sense, proceed cautiously.

Tips for Using Home Equity to Purchase a Car

If after analysis your situation seems appropriate for using home equity to acquire a vehicle, keep these tips in mind:

• Take out the minimum amount needed rather than maxing out your equity.

• Select the shortest loan term that fits your budget to pay down principal faster.

• Make extra payments when possible to repay the debt quicker.

• Understand any prepayment penalties for accelerated repayment.

• Comparison shop multiple lenders for the best rates and fees combination.

• Use a reputable lender like a bank or credit union versus lesser known companies.

• Pick the most moderately priced, reliable used vehicle that meets your requirements.

• Avoid costly add-ons that don’t enhance safety or value.

• Maintain gap insurance to cover any shortfall between loan balance and car value.

• Start saving immediately for your next car to eventually pay cash if possible.

The Potential Alternatives to Using Home Equity

If after reviewing the downsides of tying your home to a depreciating asset, you determine it’s too risky, other options to buy a car include:

• Save up to pay cash or make a larger down payment if time allows.

• Have a co-signer with better credit cosign the auto loan.

• Trade in your existing vehicle to lower the amount financed.

• Buy cheaper used vehicles and accelerate savings for a better car later.

• See if you qualify for special financing incentives with auto manufacturers.

• Avoid unnecessary add-ons and fees to reduce the sale price.

• Take out a small personal loan with a shorter term and pay off faster.

• Use peer-to-peer lending sites to source competitive financing rates.

• Pay down other debts and continue building your credit to improve scores.

For many buyers, the smarter choice is passing on home equity loans altogether and opting for more affordable transportation until they’re in better financial shape. Saving diligently for a larger down payment or paying cash outright for used cars bought sensibly provides freedom from the burden of yet more debt.

The Bottom Line

Using home equity should be handled with great care and loans considered solely for assets likely to appreciate, like renovations – not vehicles that lose significant value. While possible and maybe warranted in certain situations, the risks usually outweigh potential benefits of tying your home to a rapidly depreciating car. Thoroughly explore all alternatives and utilize the tips provided to determine if tapping equity makes sense. Proceed cautiously and only if you’re confident it’s the most prudent financial path for your situation.