There are several ways to finance a new or used car purchase, including using a home equity loan.
While buying a car with a home equity loan has unique benefits, it also has a number of downsides (and potential risks) to consider. Before you use a home equity loan to purchase a new vehicle, consider comparing loan options from auto lenders below.
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What Is a Home Equity Loan?
A home equity loan allows you to borrow money against the equity in your home, using your property as collateral. Simply put, equity is the difference between your home’s market value and the balance of your mortgage. The more equity you have, the more money you can borrow.
However, you can’t usually borrow your entire equity balance. Instead, your lender will authorize a loan amount that’s roughly 80 percent of your home’s appraised value or a portion of its combined loan-to-value ratio. Like all loans, your interest rate and other loan terms will depend on your credit score and similar factors.
Home equity loans come in two varieties:
Fixed-rate home equity loans give borrowers a one-time lump sum. Traditional home equity loans have a set repayment term, just like a conventional mortgage. You make regular, fixed monthly payments that include both principal and interest over a certain period, usually five to 15 years.
Home Equity Lines of Credit (HELOC)
A HELOC is a home equity line of credit. Think of it like a revolving credit card, in that you can draw on the available balance whenever you need it. Once you pay it back, you can use it again and again.
Your lender will determine the term, and if you opt for this type of home equity loan, expect the bank to assign a variable interest rate. The draw period is usually between five to 10 years, while the following repayment period can extend a decade or longer.
Can You Buy a Car with a Home Equity Loan?
You can use a home equity loan for any purchase, including a new or used car. However, using an equity loan to purchase a car is a much different process than getting auto financing from a car dealership.
It often involves getting your home appraised to figure out exactly how much equity you have. In addition, there’s a limit to how much money you can take out, which will impact how much car you can afford.
Advantages of Using Your Home Equity to Buy a Car
Your home’s equity can be an easy source of cash. Plus, home equity loans come with low-interest rates and possible tax deductions, making them appealing choices for car buyers. Here are some advantages of buying a car with a home equity loan:
Flexible Repayment Terms
The repayment terms on most auto loans run from 24 months for a used car to 84 months for a new model. A home equity loan gives you a significantly longer timeframe to repay the debt. Most banks will extend terms between 10 and 15 years or more. You can also typically pay off a home equity loan early with no penalties, which isn’t the case with every car loan.
Low Monthly Payments
Because home equity loans usually have longer repayment periods, you’ll pay less each month than with an auto loan. With some new car monthly payments exceeding $1,000, saving that money could make a big difference in your financial situation.
Most lenders charge lower interest rates on home equity loans because they’re secured by your house. If you have an excellent credit score, you might be able to qualify for a rate under 3 percent.
Disadvantages of a Home Equity Loan
Taking out a home equity loan to buy a car can seem like a great idea, especially if you have a steady income and a large percentage of equity in your home. However, using a home equity loan has downsides. Here are a few things to consider before you choose this option:
Risk of Foreclosure
When you take out a home equity loan, your house is used as collateral. That means if you default on the loan, the lender can foreclose on your home. Using your property as collateral just to buy a vehicle is a risky option, especially when there are safer methods available.
You Could Struggle to Sell Your Home
If you need to sell your home, you could end up on the losing end of the sale. Specifically, this can be a problem if you need to sell your house before you’ve paid the home equity loan back. If you become upside down on your mortgage and your home value decreases, it could prevent you from selling the house altogether.
You Lose Available Equity
When you use your home’s equity to purchase a vehicle, you no longer have the option to use the equity for a bigger, more important purchase. For example, if you needed to come up with money fast to cover unexpected medical bills, you would no longer be able to leverage your home’s equity to access cash.
Adds Depreciation Costs
While your home’s market value is likely increasing, your car’s value is not. Your brand-new vehicle is going to depreciate quickly and will lose about 20 percent of its value during the first year. When you buy a car with a home equity loan, you’ll pay for the vehicle long after its value has dropped. Remember the real estate market fluctuates, too. So if your home’s value decreases, you could end up owing the bank more than it’s worth.
Longer Loan Terms
While a benefit of home equity loans is a longer repayment period, this extended timeline could also outlive your car. For example, if your auto loan is $20,000 and you take 12 years to pay it off using a home equity loan, you might not be driving your car at the end of that 12-year period.
Higher Interest Expenses
A longer repayment timeline with a home equity loan also means paying more money in interest. If you chose a traditional car loan with a shorter repayment period of three years or less, you would pay significantly less interest on the vehicle.
Temptation to Spend More
If you choose to take out a HELOC instead of a one-time, fixed-rate home equity loan, you might be tempted to purchase a car you can’t really afford. Resist the urge to spend your equity balance as you earn it back. Otherwise, you run the risk of accumulating more debt and putting your house in jeopardy.
Finance & Insurance Editor
Elizabeth Rivelli is a freelance writer with more than three years of experience covering personal finance and insurance. She has extensive knowledge of various insurance lines, including car insurance and property insurance. Her byline has appeared in dozens of online finance publications, like The Balance, Investopedia, Reviews.com, Forbes, and Bankrate.