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When it comes time to finance a major purchase like a car homeowners often face the decision between getting a traditional auto loan or tapping into their home equity. Both options have their pros and cons so it’s important to weigh them carefully based on your financial situation and goals. This guide examines the key differences between home equity loans/lines of credit and auto loans to help you determine which is the better fit.
An Overview of Home Equity Financing
Home equity refers to the portion of your home that you fully own, calculated by subtracting the amount you still owe on your mortgage from the current market value. For instance, if your home is worth $300000 and you owe $180000 on your mortgage, you have $120,000 in equity ($300,000 – $180,000 = $120,000).
You can leverage your equity in two main ways:
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Home Equity Loan: This provides you with a lump sum of cash upfront at a fixed interest rate. The loan amount, repayment terms, and interest rate are all set when you first take out the loan.
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Home Equity Line of Credit (HELOC): This functions like a credit card, giving you access to a revolving credit line up to a set limit. You can withdraw as needed and only pay interest on what you actually use. HELOCs typically have variable rates.
In both cases, your home serves as collateral for the debt. If you fail to repay, the lender can seize your home through foreclosure.
Key Attributes of Auto Loans
Auto loans are a popular way to finance the purchase of new or used cars. With an auto loan:
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The car itself serves as collateral. Defaulting means the lender can repossess your vehicle.
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Loans typically last 2-7 years. Longer terms up to 8 years may be available for pricier cars.
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Interest rates are usually fixed but can be variable. Rates range from 3-20%+ based on your credit, loan term, and other factors.
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Auto loans can be obtained directly through a dealership, bank, or credit union. Online lenders are also an option.
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Approval is quicker than home equity products, often in just 1-2 days. You’ll need a valid driver’s license and proof of income.
Comparing Home Equity vs. Auto Loans
Below is an overview of how key features of home equity loans and lines stack up against auto financing:
| Home Equity Loan | HELOC | Auto Loan | |
|---|---|---|---|
| Collateral | Your home | Your home | The vehicle |
| Term Length | Typically 10-30 years | Usually 10 years (up to 20) | 2-7 years (sometimes up to 8) |
| Interest Rate | Fixed | Variable | Usually fixed but can be variable |
| Repayment | Fixed monthly payments | Flexible payments (interest-only during draw period) | Fixed monthly payments |
| Approval Time | 30-60+ days | 30-60+ days | 1-2 days |
As you can see, home equity products offer longer repayment terms but involve putting your home at risk as collateral. Auto loans are faster to get but have shorter terms and higher monthly payments.
Pros and Cons of Using Home Equity to Buy a Car
Below are some potential advantages and disadvantages of financing a car with home equity:
Pros
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Lower monthly payments: The longer term lengths allow you to spread repayment over more years, reducing your monthly cost.
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Fixed rates with HELOCs: HELOCs offer the flexibility of a line of credit with the stability of fixed rates on any withdrawals.
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Access more funds: You can tap into your equity for larger loan amounts than most auto lenders permit.
Cons
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Your home is collateral: If you fail to repay, you could lose your house to foreclosure.
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Closing costs: Home equity loans often charge 1-5% in upfront fees. Auto loans have little to no fees.
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Rates may be higher: Currently, average auto loan rates are lower than rates for home equity financing.
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Lengthy approval process: Home equity applications can take over a month versus just days for auto loans.
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Interest may not be deductible: For tax year 2022, interest is only deductible if used for home improvements.
When Does It Make Sense to Use Home Equity for a Car?
As the cons indicate, tread very carefully when thinking about using home equity to purchase a vehicle. A car is a depreciating asset, so you don’t want to put your home at risk for something that will lose significant value over time.
That said, here are a few situations where it could be reasonable:
- You have a large amount of equity built up and want to keep monthly payments low.
- You have excellent credit but need a larger loan amount than most auto lenders will provide.
- You plan to use some of the funds for home renovations or repairs in addition to buying the car. This makes better financial sense than using home equity for the car alone.
- Interest rates on home equity loans are competitive with or lower than current auto loan rates you’ve been quoted.
Even in these cases, be sure to crunch the numbers carefully and consider all alternatives before moving forward. An auto loan is still likely the safer choice in most circumstances.
The Bottom Line
When weighing home equity loans/lines against auto loans, consider how much equity you have, your current debt, the amount needed, and your credit history. For most people, the risk of putting your home on the line makes standard auto financing the better option for purchasing a car. But home equity can be reasonable if used prudently and in certain situations. Be sure to evaluate both paths thoroughly based on your personal financial picture.
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Should I use my home equity to buy a car?
Frankly, no. Avoid buying a car using home equity, if possible.
With a home equity loan, your home is the collateral for the debt. If you fall behind on repayment, the lender can foreclose on the home. Translation: You could lose it.
That goes for home equity lines of credit (HELOCs), too. Can you use a HELOC to buy a car? Sure. But should you? Probably not, and for the same reason: That line of credit uses your home as collateral, putting what’s likely one of your biggest assets at risk.
Generally, it’s best to tap your home equity if you’re going to spend the funds on projects or expenses that further your financial or professional well-being, such as renovating your house or paying college tuition. Because cars don’t hold their value well over time, it doesn’t make sense to tie your home up with financing for one — you’d be repaying a loan on an item that won’t be worth much when all is said and done. (In contrast, real estate generally appreciates over time, especially when money is spent to improve the property.)
Can I Use My Home Equity Credit For Car Payments?
FAQ
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