Consolidating debt is one of the most common reasons people take out a home equity line of credit, or HELOC. It’s the second-most-popular use after home renovations, according to a MarketWatch Guides survey.
But should you use a HELOC to pay off a car loan as part of that? There are some advantages to doing so, including the fact that you can secure a lower interest rate on a HELOC than you have on your auto loan. But there’s also considerable risk. The main one: You may put your home in jeopardy if you can’t make your payments.
In this article, we’ll go over the pros and cons of using a HELOC to pay off a car loan and things to consider before doing so.
Buying a new car is an exciting experience. However it also usually requires taking out a loan to finance the purchase. You have two main options for an auto loan – a traditional car loan or a home equity line of credit (HELOC). But which one is the better choice? In this comprehensive guide we’ll compare HELOCs and car loans to help you decide which is better for financing your next vehicle.
What is a HELOC?
Let’s start by understanding what a HELOC is HELOC stands for Home Equity Line of Credit, It allows homeowners to borrow against the equity they have built up in their home
A HELOC works just like a credit card. Your lender approves you for a set credit limit, say $50,000. You can then borrow up to that limit at any time, repay it as you choose, and borrow again as needed. HELOCs have variable interest rates, so your monthly payments fluctuate based on current rates.
The main benefits of a HELOC are:
- Lower interest rates than most other types of loans
- Flexible repayments
- Ability to borrow up to your limit repeatedly
Using a HELOC to buy a car means pledging your home as collateral for the loan. If you fail to repay the HELOC, the lender can foreclose on your house. So this option does come with risks.
What is a Car Loan?
In contrast to a HELOC, a car loan is a loan designed specifically to finance a vehicle purchase. You borrow a set amount for the car’s price, taxes, fees, etc. The lender places a lien on the car title until you repay the loan.
Car loans are closed-end installment loans, meaning:
- You receive the full loan amount upfront in a lump sum
- The loan has fixed monthly payments
- It has a set repayment term, usually 3-6 years
- You cannot borrow additional funds after getting the initial lump sum
Car loans tend to have higher interest rates than HELOCs. But they don’t put your home at risk if you default. The lender can just repossess your car.
HELOC vs Car Loan: Key Differences
Now that we’ve explained both loan types, let’s directly compare HELOCs and car loans across some key factors:
Interest Rates
- HELOCs – Have variable rates tied to the prime rate, currently averaging 7% to 10%
- Car Loans – Have fixed rates averaging 4% to 20% based on your credit
In general, HELOCs tend to offer lower rates. But it depends on your credit score and current prime rate. With excellent credit, a car loan could beat a HELOC.
Fees
- HELOCs – 2% to 5% origination fee on the credit limit
- Car Loans – 1% to 2% origination fee on the loan amount
HELOCs usually have higher upfront fees due to the home appraisal required
Loan Amount
- HELOCs – Up to 85% of your home’s value minus mortgage debt
- Car Loans – Typically $5,000 to $75,000
HELOCs allow you to borrow more since your home collateral is worth considerably more than a car’s value.
Repayment Term
- HELOCs – 10 to 20 years
- Car Loans – 3 to 6 years
HELOCs offer much longer repayment periods, leading to lower monthly payments.
Security Requirements
- HELOCs – Your home as collateral
- Car Loans – The car as collateral
This is the biggest difference. Defaulting on a HELOC risks foreclosure, while defaulting on a car loan just results in repossession of the vehicle.
When Does it Make Sense to Use a HELOC?
Given the differences above, in what situations does it make more sense to use a HELOC over a traditional car loan?
You Need a Larger Loan Amount
If you need to borrow more than a typical car loan allows, like over $75,000, a HELOC may be your only option. The high limit lets you buy a more expensive luxury vehicle.
You Want Lower Monthly Payments
The longer repayment terms of HELOCs translate to lower monthly payments. If cash flow is tight, the smaller payments of a HELOC may fit your budget better than a car loan.
You Have Good Credit
Those with excellent credit scores above 740 have the best shot at qualifying for a low HELOC rate under 5%. The HELOC may be cheaper than a car loan in this case.
You Plan to Repay Quickly
Even though HELOCs have long terms, you can repay them early without penalty. If you take a 10-year HELOC but plan to pay it off in 3 years, you can minimize interest costs.
You Need Flexible Access to Funds
HELOCs give recurring access to borrowed funds. If you want to use it for other expenses beyond just the car purchase, a HELOC provides flexible financing.
When Does a Car Loan Make More Sense?
On the other hand, here are some situations where a dedicated car loan may be the smarter choice over a HELOC:
You Want to Keep Home and Auto Loans Separate
If you don’t want to risk your home by borrowing against it, a car loan lets you keep the financing isolated to just the vehicle.
You Want Lower Upfront Fees
The appraisal and origination fees on a HELOC can be thousands of dollars. A car loan has lower fees, saving you money when starting the loan.
You Want a Fixed Interest Rate
Car loans offer fixed rates that don’t change over the full repayment term. With a HELOC, you take on interest rate risk.
You Have Lower Credit Scores
Those with fair or bad credit may not qualify for a decent HELOC, but can still get approved for a subprime car loan.
You Only Need a Small Loan
If you just need a few thousand dollars for a used car, a low amount HELOC probably isn’t worth the fees and home risk.
Tips for Getting the Best Rate on a Car Loan or HELOC
Whichever financing option you choose, here are tips to get the lowest rate possible:
- Shop around with multiple lenders to compare rates
- Ask lenders about discounts for setting up autopay
- Pay down other debts to lower your debt-to-income ratio
- Make a large down payment of 20% or more
- Improve your credit score before applying
- Consider asking a family member to co-sign the loan
- Look for manufacturer financing deals if buying new
Every little bit helps drive that rate down!
The Bottom Line
Let’s recap the key similarities and differences:
Similarities:
- Both allow you to finance a car purchase
- Require paying interest and fees on the loan
Differences:
- HELOCs risk your home as collateral
- Car loans have fixed rates and terms
- HELOCs offer lower rates and costs for those with good credit
- Car loans accommodate smaller loan amounts and lower credit scores
Look at your specific financial situation and car buying needs to determine if a HELOC or traditional car loan better matches your goals. And be sure to carefully weigh the risks and rewards of pledging your home equity. With some thoughtful analysis, you can pick the ideal loan option and get a great new car!
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What is a HELOC?
A HELOC is a secured loan that uses your home equity as collateral. The equity in your home is the difference between what you owe on your mortgage and the appraised value of your home. A HELOC is a revolving line of credit, similar to a credit card, that homeowners can draw on as needed. Your credit limit on a HELOC is determined by the lender.
You can access your line of credit in your HELOC during the draw period, which typically lasts for a set term. During the draw period, you can make interest-only payments on the money you borrow, depending on your loan terms.
After the draw period ends, you enter your repayment period during which you must pay off your outstanding balance in regular payments of the principal and interest on the loan. The repayment period is also a set number of years as determined by your lender. A HELOC generally has a variable interest rate rather than a fixed rate, so your payment amount can fluctuate over time.
You can use a HELOC to finance home improvement projects or renovations that your savings or income can’t cover. You can also use a HELOC to pay off larger existing debt, such as higher education loans, auto loans or for debt consolidation. Be aware that the interest on a HELOC may be tax deductible only if you use it to make improvements or renovations that add value to your home.
Alternatives to Using Home Equity
If you are looking to pay off your car loan, there are other options you can explore besides using a HELOC. In most cases, sticking with your existing car loan payments is the best way to go.
But it may be worth considering alternatives as they may present lower risks than using your home’s equity to get rid of your car debt.
- Personal loans: These loans are often unsecured, meaning you won’t need to provide collateral to secure your debt. They also have fixed interest rates to simplify planning for your monthly loan payment. You can also have access to your funds more quickly than with a HELOC. Personal loans, however, might have lower limits and may not cover your full debt amount. Also, you typically need a good credit score to qualify for a lower interest rate on a personal loan.
- Balance transfer cards: These credit cards offer a no-interest or low-interest balance transfer to pay off your car loan. This can allow you to make smaller monthly payments to pay off your debt. Not all credit card companies allow you to balance transfer a loan, so check with the card issuer. It’s important to be aware that once the limited-time promotional interest rate expires, the interest rate on the card may end up being higher than your original auto loan. You may also have to pay a balance transfer fee, which is usually a percentage of the balance transferred.
Should you purchase a car with a HELOC?
FAQ
Is it smart to pay off a car with a HELOC?
Is there a downside to having a HELOC?
Are HELOC rates lower than auto loan rates?
Does a HELOC damage your credit?
What is the difference between a HELOC and a car loan?
Look at the differences in interest rates between the two loans — your auto loan has a fixed rate, while a HELOC will likely have a variable rate that can fluctuate and change your payment over the life of the loan. Determine if, even with changes in the variable rate, you will see any savings from interest.
Should I pay off my car with a HELOC?
Reduced home equity: Using a HELOC to pay off your car reduces the available equity in your home. Additionally, if your home’s value were to go down at some point during your HELOC loan’s term, you could fall into a negative equity situation where you end up owing more than the home is worth.
Should I use a home equity loan or HELOC to buy a car?
At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Here’s an explanation for Generally, you shouldn’t use a home equity loan or HELOC to buy a car.
Should I use a HELOC or a fixed-rate loan?
Auto loans, home equity loans and cash-out refinances all typically come with fixed APRs, meaning that your interest rate will not change during your repayment period. But if you’re looking for a variable-rate loan that taps your home equity, you may want to use a HELOC.