A home equity loan or home equity line of credit (HELOC) is a popular way to pay for a home renovation. But these low-interest loans may also be a good choice for a major purchase, such as a new vehicle. In fact, it can often beat that zero-percent financing deal offered by the car dealership.
Here are some of the benefits of going with a home equity loan rather than more conventional financing:
- Low rates. Auto dealers are in the car business, not the money-lending business, so when they offer their own financing deals, they almost always mark up the rate. A home equity loan will usually carry more favorable terms than what you would get at the car lot. And even getting a rate that’s just 0.5 percent less will save you money. For example, on a $20,000 loan, the difference between 6 percent and 6.5 percent over four years is more than $200 in interest.
- Bargaining power. By getting approved for a home equity loan before you visit the dealership, you may be able to negotiate a better price. In addition, dealers that advertise zero-percent financing often offer a rebate to buyers who pay the full price up front. Your home equity loan will allow you to take advantage of this rebate.
- Tax savings. Unlike a car loan, the interest you pay on a home equity loan may be tax-deductible. Let’s say you took out a $20,000 home equity loan at 6 percent and paid it off in four years. Over the course of the loan, you’d pay about $2,500 in interest. If you’re in a 25 percent income tax bracket, deducting this amount would save you more than $600 over the four years. Before you count up these savings, however, talk to a tax adviser to make sure you qualify.
Home equity loans also carry inherent costs and risks, however, and are not always the most appropriate way to finance your new car. Here are some of the potential drawbacks you should consider:
- Closing costs. Processing a home equity loan may involve higher upfront fees than taking out a car loan. In addition, adding a second mortgage may require you to purchase private mortgage insurance (PMI). This additional cost could eat up any savings you’d get from the better interest rate.
- Interest rates may rise. A home equity line of credit is often a good option to finance a car because it usually carries lower closing costs than a home equity loan. However, a HELOC, unlike a car loan, usually has a variable rate and over several years the rate could rise significantly, making it more difficult for you to meet your payments.
- You’re putting your home on the line. If you fail to make your car loan payments, the vehicle may get repossessed. However, the consequences of defaulting on a home equity loan are much more serious -- you may be forced to sell your house. If you decide to secure your vehicle loan with your home, you must have the discipline to make all the payments on time.