Using a home equity loan to purchase a car can save you money, but there can also be drawbacks. If you are wondering how to finance your next car, knowing both the advantages of using a home equity loan to purchase a car and what to watch out for can help you make the best decision for your situation.
Here are some potential advantages of using a home equity loan to finance a car:
- It may be easier to get a home equity loan. Both car loans and home loans are secured by collateral, but most lenders would consider a home to be a more solid form of security since they are less prone to depreciate. This might make it easier for you to get a home equity loan than a car loan, especially if you have a shaky credit history.
- Your interest rate may be lower. That greater security that a home represents as collateral should also help you get a lower interest rate than an auto loan for a home equity loan of comparable length.
- You may get a tax deduction on your interest. Not only might you get a lower interest rate on a home equity loan, but if you itemize deductions, the tax on that home equity loan interest might be deductible. This could further add to the cost advantage of a home equity loan over an auto loan.
What to Watch Out For
Despite the advantages, using a home equity loan to purchase a car is not a slam dunk. There are some potential complications to watch out for:
- Reducing your equity by too much can limit future refinancing options. Equity in your home is an asset that should be used wisely. If you use it to buy a car, reducing the equity cushion you have might limit your ability to refinance your home in the next few years, especially if housing prices dip. So, before you make this decision think about how likely you are to want to refinance in the coming years.
- Be careful about extending debt beyond the useful life of an asset. You can get a home equity loan for a longer term than you are likely to get a car loan, but that probably isn't a good thing. Extending loan terms beyond the useful life of what you are purchasing is often a way of building up debt over time. Whether you use a home loan or an auto loan, keep the length of the loan under the likely useful life of the car.
- Make sure the monthly payment burden doesn't put your home at risk. Never confuse the ability to get a loan with the advisability of taking on those payments. Make sure the payments from a home equity loan would fit comfortably into your budget, because that form of financing puts your home on the line.
- Look at total interest cost over the life of the loan. Since home equity loans are often for longer terms than car loans, you need to compare more than just the interest rate and the monthly payment. Paying interest over a longer period may result in you paying more total interest over the life of the loan, even at a lower interest rate. Make sure you look at a comparison of the total interest that would be paid before you make your decision.
To really make an informed decision on using a home equity loan to purchase a car, you need to go beyond generalities and identify just how much money you stand to save. Use a loan calculator to compare loan terms, and don't forget to also factor in the tax advantage of a home equity loan, if applicable to your situation. Once you know what the potential savings are, you can weigh them against the possible drawbacks to draw a conclusion that will work best for you over the life of the loan.