Can You Use a Home Equity Loan to Buy a Car?
Yes, you can use a home equity loan to buy a car. At first glance, it can seem like a good 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 most auto loans. However, using home equity to buy a car also comes with some big risks and drawbacks.
Here’s what you need to know before putting your home on the line.
- You can use a home equity loan for just about anything, but it’s generally considered unwise to use it to buy a car.
- Your car will likely lose value faster than you can pay off the home equity loan, plus you’ll risk foreclosure if you can’t afford to make the payments.
- It’s likely a better idea to try to get the best possible rate on an auto loan instead.
Is using a home equity loan to buy a car a good idea?
While you can technically use home equity loan for any purpose, including a car purchase, financial advisors generally don’t recommend it. Here’s a look at some of the major risks you could be taking if you choose to go this route:
Disadvantages of using a home equity loan to buy a car
- Depreciation timeline. Unlike homes, cars lose their value quickly. New cars lose 60% of their value over five years, according to Kelley Blue Book. Since home equity loans and home equity lines of credit (HELOCs) typically have longer repayment terms, you risk falling underwater after your car loses value.
- Possibility of foreclosure. Home equity loans and HELOCs use your home as collateral to secure the loan. 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, which can be costly. In contrast, with an auto loan, you only have to worry about potentially making a down payment and paying some smaller dealer fees.
- Long-term cost. The longer repayment terms associated with home equity loans can mean paying far more money overall, particularly in interest charges.
Although mortgage interest rates are coming down, they are still 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.
- Losing equity. Increasing the overall amount you owe on your home means losing some of your home equity. If your home’s market value drops, you could risk owing more than the house is worth.
Alternatives to buying a car with a home equity loan
The best alternative to using a home equity loan to buy a car is to get an auto loan. Still, if you have a lower credit score, getting a bad credit auto loan can be costly, which might make a home equity loan’s lower interest rates seem appealing.
However, there are steps that you can take to improve your chances of getting the best auto loan rates possible, including:
- Improving your credit score: The lowest interest rates are often given to those with the highest credit scores, which means that taking the time to improve your credit score can help you save big on your auto loan.
- Make a bigger down payment: If you can, save up money to make a larger down payment on your car. Not only will doing so reduce the amount that you’re borrowing and, by extension, your monthly payment, but there’s a chance that your lender might give you a better deal because you have more skin in the game.
- Get prequalified: Getting preapproved for a car loan can help you have a better idea of how much you can afford to spend. Plus, having some loan terms in writing may give you more leverage when talking to car dealers.
- Use a cosigner: If you have a trusted friend or family member, consider asking them to be your auto loan cosigner. Just remember that they’ll be on the hook for repayment if you default on your car loan.
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Compare: Home equity loan vs. car loan
To help you decide, here’s a quick side-by-side look at home equity and auto loans:
| Home equity loans | Auto loans | |
|---|---|---|
| Required collateral | Home | Car |
| Average repayment term | 5 to 30 years | About 6 years |
| Lender’s fees | 2% to 5% of the loan amount in closing costs | 8% to 10% of the car’s purchase price in dealer 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 661 will likely have higher rates |
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 60% in the first five years. By 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 six 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, as you’re paying interest for much longer.
- Interest rates Historically, home equity loan rates have been significantly lower than auto financing. However, while mortgage interest rates are falling, they could still be higher than auto loan rates. Your rate quote will depend largely on your credit score and the lender you’re working with.
- 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 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.
How to use your home equity to buy a car
If you’re set on leveraging your home equity to buy a car, there are three types of loans that will allow you to do so:
Home equity loan
A home equity loan allows you to take out a portion 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 borrow in addition to your first mortgage loan.
- 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 refinance your first mortgage.
Home equity line of credit (HELOC)
A HELOC is a revolving credit line, 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: Credit line
- Repayment: Monthly payment is based on what you borrow, not your total credit line amount.
- Loan terms: Some HELOCs require payment due immediately when the draw period ends, but others may give you 10 to 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 existing mortgage, or if you want to change your loan repayment term.
4 steps to buy 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 100% 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 shop around with other lenders. You’ll find that different lenders have different home equity loan requirements and rates.
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 just a few days.
Step 4: Receive the funds
You’ll receive the money soon after being approved 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 then use the money to buy a car.
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