How to Use a Home Equity Loan to Buy a Car
Taking out an auto loan may seem like the only way to purchase your next vehicle, but learning how to use home equity to buy a car could change your mind.
If you have equity in your home, you may be able to take out a home equity loan for your auto purchase. We’ll cover important information about how a home equity loan can help you buy a car, and the pros and cons of each financing option.
How to use home equity to buy a car
If you have home equity (the difference between your home’s value and your mortgage balance) in your home, you could use your equity to take out a loan. Here are three options to choose from if you’re considering using home equity to buy a car.
A cash-out refinance involves taking out a new loan to pay off what you owe on your current mortgage, plus borrowing additional funds. Once you pay off your original mortgage, you’ll receive a lump sum for the remaining amount you borrowed. You can use that money for whatever you choose, including a car purchase.
This type of refinance might help you get better terms on your mortgage, too. You may be able to qualify for a lower APR than your first mortgage or change the length of your loan repayment to better suit your needs.
Home equity loan
A home equity loan (HEL) 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.
After receiving your lump sum, you’ll have to pay back the HEL in monthly installments. The typical repayment term is five to 15 years and interest rates are fixed.
Home equity line of credit
A home equity line of credit (HELOC) is a revolving line of credit. You can borrow from your credit up to a certain limit and only during a period of time (“draw period”) your lender determines. You only have to pay back what you spend, plus interest. Rates on HELOCs are typically variable.
Steps for buying a car with a home equity loan
Step 1: Look at the numbers
The first step in taking out a HEL is to figure out what you can afford in terms of your monthly loan payment. This is important with any loan, but particularly crucial with a home equity loan since you could risk foreclosure if you fail to pay back your loan.
Step 2: Shop around
Next, you’ll want to search for a lender who offers home equity loans. 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 borrowing requirements and rates.
For example, some lenders may offer loans equaling up to 95% of your equity, while others limit home equity loans to a lower amount. One lender may approve you for better rates than the other, which could make a difference of thousands of dollars in interest payments.
Step 3: Apply for a loan
To apply, you’ll typically need to submit income verification, information about your debt, schedule an appraisal, and you may be required to have a minimum credit score of 620 or higher. 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. At that point, you can use the money to buy a car.
Pros and cons of using home equity to buy a car
Competitive interest rates. Interest rates on home equity loans tend to be lower than auto loans and much lower than average rates for credit cards.
Lower monthly payments. Auto loans for new cars are repaid in around six years, on average, but a home equity loan may be repaid over 10 years, 20 or even 30 years. A longer repayment term means lower monthly payments for the same loan amount.
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 going underwater.
Possibility of foreclosure. Home equity loans require you to use your home as collateral, meaning that even if you only borrow a small amount, you could still risk incurring major fees and go into foreclosure if you default on 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 fees.
Long-term cost. Even with lower interest rates, a longer repayment term can mean paying 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 considered a very bad investment.
Comparing a home equity vs. auto loan
Here’s a quick look at the differences and similarities between loans based on home equity vs. auto loans:
|Home equity loan||Auto loan|
|Average repayment Term (years)||5-20||6|
|Lender’s fees||2%-5% closing costs||0%-2% origination fee|
|Rate type||Usually fixed||Usually fixed|
Differences between home equity and auto loans
There are several important distinctions to note before deciding between an auto loan and tapping into your home equity:
- Type of collateral. Both types of loans require you to secure the loan with your property as collateral. For an auto loan, your collateral is the vehicle, and for a home equity loan, your collateral is your home.
- 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 20-year period, meaning lower monthly payments but higher overall interest costs.
- Interest rates. While interest rates can vary based on the market, your credit and other factors, home equity loan rates tend to be significantly lower than auto financing.
- Fees. Lender fees for both types of loans are charged as a percentage of your loan amount. For an HEL, you may pay more in closing costs, but for an auto loan, you may have to pay an origination fee to the lender, plus dealer fees.
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 a set, monthly payment until the balance is paid off.
- Fixed rates. Auto loans, HELs and cash-out refinances typically come with fixed APRs, meaning that your interest rate will not change during your repayment period for either type of loan.