How to Use a Home Equity Loan to Buy a Car
Using a home equity loan to buy a car can seem like a great idea: Your house serves as collateral, and you use the payout to buy a car at a far lower interest rate than you’d get with an auto loan. That can mean lower payments and more buying power, too.
However, using home equity to buy a car comes with some big risks and drawbacks. We’ll cover when it’s a good idea to pull equity from your home and how the process works.
Using home equity to buy a car: How it works
Home equity is the difference between your home’s value and your outstanding mortgage balance — it’s the portion of your home that you own outright. Using your home equity as collateral can help you finance your car at a low interest rate.
But securing a loan with your house means that, if for some reason you can’t keep up with your loan payments, you could lose it to foreclosure. That’s an asset worth far more than a car, so it’s a big risk to take.
There are three types of loans that allow you to tap your home equity to buy a car:
Home equity loan
A home equity loan allows you to take out some or all of the equity in your home as a lump-sum payment. You may also hear this referred to as a “second mortgage,” since it’s a loan you take out in addition to your first mortgage.
- Interest rates: Fixed
- Payout type: Lump sum
- Repayment: Monthly installments
- Loan terms: Usually five to 15 years
Using a home equity loan to buy a car makes the most sense if you want stable payments that won’t change, or if you don’t want to alter your first mortgage.
Home equity line of credit (HELOC)
A HELOC is a revolving line of credit, much like a credit card. You can borrow up to a certain limit, pay off some or all of what you’ve used and then spend more if you’d like. However, you can only use the credit during a certain period of time called the “draw period.” After that, you’ll have to pay back what you spent, plus interest.
- Interest rates: Variable
- Payout type: Line of credit
- Repayment: Monthly payment based on what you spend, not your total credit line amount
- Loan terms: Some HELOCs require payment due immediately when the draw period ends, but others may give you around 20 years to repay the loan.
Using a HELOC to buy a car makes the most sense if, in addition to the car, you want to use the loan to cover ongoing expenses or consolidate debt.
Cash-out refinance
With a cash-out refinance, you take out a new loan that’s larger than your current loan. It pays off what you owe on your current mortgage, and you’ll pocket the additional funds in cash. You can use that money for whatever you choose, including a car purchase.
- Interest rates: Fixed or variable
- Payout type: Lump sum
- Repayment: Monthly installments
- Loan terms: Typically 15 to 30 years
Using a cash-out refinance to buy a car makes the most sense if you can get a lower rate than you have on your first mortgage, or if you want to change the length of your loan repayment period.
Compare: Home equity loan vs. car loan
Here’s a quick side-by-side look at home equity compared to auto loans:
| Equity loans | Auto loans | |
|---|---|---|
| Required collateral | Home | Car |
| Average repayment term | 5 to 30 years | About 6 years |
| Lender’s fees | 2% to 5% in closing costs | 0% to 2% in origination fees |
| Payment type | Monthly payments | Monthly payments |
| Rate type | Fixed or variable | Usually fixed |
| Credit score minimum | 620 | No minimum, but those with a score below 660 will likely have higher rates |
Current interest rates are high: Mortgage rates are higher right now than they’ve been in over 20 years, so there’s no guarantee that a home equity loan will actually get you a lower rate than an auto loan.
Key differences between home equity and auto loans
Type of collateral
Both types of loans require you to secure the loan with your property, but the two types of collateral aren’t created equal. A car depreciates over time — for a new car that loss of value can be as much as 20% within the first year and 40% in the first 5 years. In contrast, a house and the land it sits on typically hold their value well.
Repayment terms
The average loan term for a new or used vehicle is around five years, but home equity loans are typically paid back over a five- to 30-year period — meaning lower monthly payments and more buying power with an equity loan. However, the trade-off is higher overall interest costs with a home equity loan since you’re paying interest for much longer.
Learn more about home equity loan terms.
Interest rates
Historically, home equity loan rates have been significantly lower than auto financing. However, mortgage interest rates are rising quickly, and today they could easily be higher than auto loan rates. Your rate depends largely on your credit score and the lender you’re working with.
View current home equity loan rates.
Fees
Lender fees for both types of loans are charged as a percentage of your loan amount. For a home equity loan or HELOC, you may pay more in closing costs — however, with an auto loan, you’ll pay an origination fee to the lender, plus dealer fees.
Sometimes known as “buy here, pay here” financing or “in-house” financing, these are car loans issued by the dealership where you buy a car, rather than a bank or credit union. They’re known for their high car prices, very high interest rates and other unsavory loan features.
Similarities between home equity and auto loans
Whether you take out an auto loan or home equity loan, you can typically expect the following similarities:
Installment payments
Both loan types will require you to make monthly payments until the balance is paid off. Depending on whether you choose a traditional home equity loan or a HELOC, your payments may stay consistent or change over time.
Fixed rates
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.
Read more about how to choose between a HELOC vs. a home equity loan.
Is using a home equity loan or HELOC to buy a car a good idea?
Financial advisors generally don’t recommend buying a car with home equity. It pays to tread carefully when tapping your home equity to purchase an asset that depreciates faster than the collateral securing that loan.
If you absolutely need a car — for instance to get to work or transport your children — you might find that a home equity loan is your best bet. But if you can stand to pursue safer options, like waiting until you’ve saved up for a car, you should. Taking the time to improve your credit score can also put an auto loan with a competitive interest rate within reach.
Disadvantages of using a home equity loan to buy a car
The lower interest rates and smaller monthly payments associated with home equity loans and HELOCs are a big draw for consumers looking to maximize their buying power. But the drawbacks are arguably far more significant:
- Losing equity. Increasing the overall balance on your home means losing some of your equity. If the market value of your home drops, you could risk owing more than the house is worth.
- Possibility of foreclosure. Even if you only borrow a small amount with a home equity loan, you could still risk losing your home to foreclosure if you don’t make your payments.
- Closing costs. Home equity loan closing costs can range from 2% to 5% of the overall loan amount. If you were to borrow $30,000, you’d have to pay roughly $600 to $1,500 in closing costs. By contrast, you’d likely only pay up to $600 in origination fees if you borrowed $30,000 with an auto loan.
- Long-term cost. The longer repayment terms of home equity loans can mean paying far more money overall, since the interest has more time to accrue.
- A poor investment. Unlike homes, cars lose their value quickly. This rapid depreciation is the reason that car buyers commonly owe more on their auto loan than their car is worth. It’s also the main reason why using home equity to buy a car is often a bad investment.
Steps for buying a car with a home equity loan
While it’s not the best strategy, some borrowers may find that using a home equity loan to buy a car is their only option. If you’re in that boat, here’s how to tackle the process:
Step 1: Look at the numbers
The first step in taking out an equity loan is to figure out what you can afford in terms of your monthly loan payment, as well as how much money you can qualify for.
Lenders use a metric called the loan-to-value (LTV) ratio to determine how much you can borrow. Most lenders set an 85% cap on your LTV, but some lenders may offer high-LTV home equity loans or HELOCs equaling up to 95% of your equity.
Step 2: Shop around
Next, you’ll want to search for a lender who offers the type of equity loan you’re interested in. A great place to start is with a bank or credit union where you already have an account, then branch out to other lenders. You’ll find that different lenders have different home equity loan requirements and rates.
Compare lenders using our list of the best home equity lenders.
Step 3: Apply for a loan
To apply, you’ll typically need to submit information about your income, debt, credit history and other aspects of your finances. Once the application process is complete, some lenders can approve you in as little as one or two days.
Step 4: Receive the funds
Depending on the lender, you could receive the money within a week of being approved. You’ll receive your loan either in the form of a cashier’s check, a direct deposit to your bank account or a wire. If you’re using a HELOC, you may get a special checkbook to use or card to swipe. At this point, you can go ahead and use the money to buy a car.
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