Using a Home Equity Loan to Buy a Car
If you’re in the market for a new car, one of the big questions you have to answer is how you’re going to pay for it. Unless you have the available savings to pay with cash, you’ll probably have to take out some form of loan.
But before you assume that an auto loan is the way to go, there are some good reasons to consider taking out a home equity loan instead.
Current interest rates are similar, with 5-year auto loans averaging around 4.75% and home equity loans in the range of 4%-5.87%, and each type of loan has pros and cons that may make it better for worse for your personal situation.
This article explains how to use a home equity loan for a car purchase to help you decide whether it’s the right move.
- How to use a home equity loan to buy a car
- Home equity loans vs. auto loans
- Benefits of using a home equity loan to buy a car
- Risks of using a home equity loan to buy a car
- Should you use a home equity loan to buy a car?
How to use a home equity loan to buy a car
According to Dan Green, branch manager for Waterstone Mortgage in Pewaukee, Wis., the process of taking out a home equity loan to buy a car is no different than taking it out for any other purpose.
“The process is relatively straightforward, especially in a rising housing market,” Green said. “For banks that do home equity loans, it’s a simple product, and you may be approved within a day or two and have your cash within a week or less.”
Green said that the first step is simply being comfortable with your ability to make the loan payments month after month, given that either your home or your car will be at risk if you can’t make those payments.
If you do decide to apply for a home equity loan, Green said that some banks will ask for income verification, such as pay stubs and W-2s, while others may not. And some banks might loan you up to 95% of the value of your home (minus your outstanding mortgage balance), while other banks may have stricter limits.
“The exact mechanics are going to vary by bank and it’s important to talk to multiple banks to compare terms,” Green said. “If you don’t like the terms you get from the first bank, it’s no problem going to a different bank.”
Once you’re approved for a loan, Green said that the money can be issued in the form of a cashier’s check, deposited to your bank account or wired to you. At that point, the money is yours to do what you’d like, including buying a car.
Home equity loans vs. auto loans
The biggest is the fact that an auto loan is secured by your car while a home equity loan is secured by your home.
“If you ever fall behind on payments with an auto loan, they’ll repossess your car,” Green said. “With a home equity loan, if you miss payments, you’re at risk of losing your house. That’s what a homeowner should think about when they’re considering whether to finance a car with a home equity loan.”
There’s also a difference in terms. Green said that most auto loans have 3- to 5-year terms while home equity loans typically have 10-year terms, though banks will offer a number of variations. This can impact the monthly payment, though you need to consider the long-term effect as well.
“A home equity loan may have a longer term, which makes the monthly payment lower,” Green said. “But it may have a higher long-term cost, so that’s a conversation to have with your loan officer.”
When it comes to interest rates, Green said that both auto loans and home equity typically offer fixed rates, so making a comparison should be relatively straightforward. You simply have to shop around to figure out where you can get a better deal.
Benefits of using a home equity loan to buy a car
There are a few good reasons to consider using a home equity loan to buy a car.
Lower interest rates
While you may have seen the car dealer commercials for 0% interest rates, Sahil Vakil, CFP, CFA and president of MYRA Capital, said that those loans can be misleading.
“When you sign up for 0% financing, it’s typically at the highest price the vehicle is selling for,” Vakil said. “If, on the other hand, you use your home equity loan to make a cash payment, you may be able to lower the price of the car, which is better than having a 0% APR financing deal. Apples to apples, in general a home equity loan is cheaper than an auto loan.”
Danna Jacobs, a CFP and founding partner of Legacy Care Wealth, said that the interest rate you get on an auto loan can depend heavily on the type of car you’re buying.
“A lot of times when you’re shopping for a new car, you can be approved for a really low-interest rate,” she said. “But if you’re buying a used vehicle, your interest rate tends to be a bit higher.”
The bottom line is that while it’s always worth shopping around and comparing offers, you will often be able to secure a better interest rate from a home equity loan, assuming that you’re comparing equal loan amounts.
According to Vakil, one of the big advantages of getting a home equity loan is that it gives you the power to negotiate a better price on the car.
“If you come to the dealership with a full cash payment, you do have negotiating power in terms of asking for a potential discount or asking for other perks such as add-on features,” he said. “You may not have that ability if you’re requesting financing from the place you’re buying the car.”
Even if the auto loan interest rate is lower, you may actually save money using a home equity loan if doing so allows you to negotiate for a lower price.
For example, let’s say that you could finance a $20,000 new car with 0% interest for five years. If instead you took out a home equity loan with 4.5% interest, used that cash to negotiate a $17,000 purchase price for the car, and paid the loan off over five years, your total loan cost would only be $19,015.88.
That’s a savings of $984.12, even with an interest rate that’s 4.5% higher.
You may already have a HELOC open
There are often closing costs involved with both a home equity loan and a home equity line of credit, which can decrease the appeal of going that route. But those costs can be avoided if you already have a line of credit open, and Jacobs said that this can be a particularly appealing route for people without traditional employment.
“A lot of entrepreneurs and independent contractors have trouble getting more traditional type of loans,” Jacobs said. “If you have that HELOC already open and available to you, that can be a big benefit.”
Of course, using a HELOC has its own drawbacks, which we’ll get into a little bit later.
Consolidate multiple loans
If you have other debts, particularly high-interest debt, Vakil suggested that you could use your car purchase as an opportunity to consolidate those loans into one home equity loan.
“If you have a credit card, student loan, and an auto loan, you can use your home equity loan to pay them all off and then only have one monthly payment at a lower rate than those other loans,” Vakil said.
Consolidating through a home equity loan might not only save you money but simplify your financial life as well.
Lower monthly payments
According to Green, auto loans typically have a 3- to 5-year repayment timeline, while home equity loans typically come with 10-year terms. This means that for the same loan amount, you’ll likely have a lower monthly payment with a home equity loan.
This is both a gift and a curse. The gift is the fact that the monthly payment will be easier to fit into your budget and potentially allow you to make more progress toward other financial goals, such as saving for retirement.
The curse is that extending the repayment period can add to the overall cost of the loan.
For example, a $20,000 loan at 4% interest paid off over five years will require a $368.33 monthly payment and cost a total of $22,099.83. That same loan paid off over 10 years will only require a $202.49 monthly payment but will cost a total of $24,298.83.
Risks of using a home equity loan to buy a car
While you might be able to get a better deal by using a home equity loan to buy a car, there are some risks and other downsides to consider before going that route.
Putting your home on the line
“The biggest risk is the collateral piece because you’re putting your home against the loan,” said Vakil. “If you’re unable to make payments, your home is gone.”
With an auto loan, the worst that can happen is that you lose your car. And while that would certainly present a challenge, it would probably be easier to deal with than losing your home.
Jacobs suggested taking a look at your local housing market in order to help you gauge this risk.
“If you are in an area where you don’t think property is appreciating steadily, you might want to reconsider maxing out the equity in your home,” Jacobs said. “If your home quickly depreciates in value and you need to sell it, you might be underwater on the loan.”
The bottom line is that if there’s any risk that you may not be able to make the payments, a home equity loan may not be a good choice.
Extended repayment period
The long-term cost of borrowing against home equity could be higher than taking out an auto loan, even if you’re able to secure a better interest rate.
“Auto loans are built to be paid off in a certain time frame, such as 4 years or 5 years,” said Lucas Casarez, CFP and founder of Level Up Financial Planning. “Most people use HELOCs as an open line of credit similar to a credit card which may only require interest to be paid, and that could allow people to pay off their loans much slower and incur more interest expense over the long run.”
If you have the discipline to pay off your home equity loan or HELOC over the same time period as a similar auto loan, you may be able to save money. Otherwise, you may just be costing yourself.
Home equity loan closing costs are typically 2%-5% of the total loan amount. Closing costs for HELOCs are often lower, though you will still usually have some upfront fees.
Even if you are able to secure a lower interest rate, those closing costs might make a home equity loan a higher cost option over the long term.
Variable interest rates
While home equity loan interest rates are usually fixed, HELOCs typically have adjustable rates that rise and fall based on market interest rates. That variability adds some uncertainty and risk, especially given today’s historically low-interest rates.
“Most HELOCs are set up with a variable rate, which means if rates continue to rise, then you will end up paying more than you initially thought,” said Casarez.
Penalties and minimums
HELOCs, in particular, can have a number of requirements and penalties, such as minimum borrowing amounts and penalties if you either pay off the loan or close the line of credit early. Those restrictions can limit your flexibility, as well as add to the cost of the loan.
“Some HELOCs, if you close it within a certain window, there is a penalty,” said Jacobs. “And if you have to move either for planned or unplanned reasons, you would have that additional cost.”
This is one of the reasons that Green encourages people to shop around. By getting multiple quotes, you’re more likely to find a loan that meets your specific needs.
Should you use a home equity loan to buy a car?
There are pros and cons to using a home equity loan to buy a car.
On the one hand, you could secure a lower interest rate and maybe even be able to negotiate a lower purchase price for your car, saving yourself significant money in the long run. On the other hand, you’re putting your home at risk in order to borrow money to buy a depreciating asset.
In the end, you’ll have to shop around, compare the offers available to you and make the right decision for your personal needs and situation. But in most cases, putting your home on the line warrants some extra caution.
Green summed it up well: “Take care with what you’re spending and how you’re spending it, especially when you’re borrowing.”