Is It a Good Idea To Use Home Equity To Buy a Car?
In general, using a home equity loan to purchase a car is a risky move you should avoid, according to Leslie Tayne, founder and head attorney at Tayne Law Group, a debt solutions law firm. If you default on the loan, the bank could foreclose on your home. “Plus, since your vehicle will depreciate fast, you’ll quickly owe more on it than it’s worth,” Tayne said in an email to The Balance. “With a long-term home equity loan, you may even end up paying on the debt long after the car is gone.” Even a brand-new, luxury vehicle suffers from depreciation, or loss of value due to use and wear. The rate of depreciation can depend on the car’s make, model, and year. In 2021, car-shopping app CoPilot found that some sedans can depreciate by as much as 71% in the first five years alone.
Ways To Tap Home Equity To Finance Your Car
It’s possible to finance a car using home equity, but generally not recommended. If you’re careful about making payments on time, it could potentially be a low-cost financing option. There are a few ways you can tap into your home’s equity to buy a car (or cover other expenses):
Home Equity Loan
Also known as a second mortgage, a home equity loan allows you to borrow against your home’s equity and receive a lump sum payment. The loan is paid back in regular installments at a fixed interest rate.
Home Equity Line of Credit
A home equity line of credit (HELOC) also lets you borrow against your home’s equity for a revolving line of credit you can borrow against as needed (up to the limit). The HELOC functions much like a credit card, with an interest rate that can go up or down over time. You might have to use the line of credit within a defined period, known as the draw period. Once the draw period ends, you’ll either renew the credit line line or start repaying the balance.
Cash-Out Refinance
Typically, you need to have at least 20% equity in your home to qualify for a cash-out refinance, although this may vary by lender. Cash-out refinancing involves taking out a new mortgage loan for a larger amount to repay, then replace the original mortgage. You pocket the equity, which can be used for whatever you want such as buying a car. The terms and interest can change and may increase or decrease your monthly interest payment.
Pros and Cons of Using Home Equity for a Car Purchase
Pros Explained
Potentially lower interest rates: Home equity loans, HELOCs, and refinancing offer far lower interest rates compared to credit cards and personal loans, and bank-originated used car loans.Longer payment timeline: Home equity loans typically involve long repayment periods, you can stretch out repayment to help improve monthly cash flow.More negotiating power: By securing your payment method ahead of time, you’re not dependent on the car dealership’s financing options. You could have more leverage at the car dealership and could get a better deal on your car’s price.
Cons Explained
Potentially higher interest rates: Rates on a home equity loan could be higher than a new-car or used-car loan you could get from a credit union or bank. Repayment period outlasts ownership and depreciation: A cash-out refinance often lasts decades, so you’ll spend more on interest charges over time. You could be paying off a lower-value vehicle long after you’ve finished driving it.Upfront costs: On paper, monthly payments may look low at first, particularly if interest-only payments. But a home equity loan or a cash-out refinance often involves closing costs that include application, appraisal, and documentation fees. Risk of losing home: Borrowing against your home equity means that your home is the physical item that promises you’ll repay your debt. If you miss payments or can’t repay the loan, the bank could foreclose on your home. If you don’t repay an auto loan, you could lose your car—but at least you’ll still have your home.
How To Get a Better Auto Loan
As you can see, using home equity to buy a car is possible, but maybe not the best move. You’re probably better off applying for a standard auto loan to save money and prevent losing your home if you fall behind on payments.
To qualify or secure good terms for an auto loan, Tayne suggested steps to improve your chances:
Boost your credit score: The best auto loan rates and terms are reserved for borrowers with high credit scores. If your credit could use some work, spend time improving it before applying for an auto loan. Scores of 740 and up are considered to be in the “good” range. Increase your down payment: When you pay more money upfront, the lender takes less risk, which helps secure a lower interest rate. Plus, you won’t need to borrow as much, so you’ll enjoy lower monthly payments and spend less on interest overall. Compare multiple loan offers: Before making a commitment, spend some time shopping for a car loan and compare interest rates, fees, and other details. Get prequalified: As mentioned above, walking into a car dealership with your financing secured in advance provides more bargaining leverage. Getting preapproved for an auto loan also lets you know exactly what budget you’re working with.
The Bottom Line
If you’re diligent about payments and confident that your income won’t change, using home equity to buy a car is possible but probably not the most cost-effective option, especially if you’re paying the debt over decades. It’s a risky move to put your home up as collateral for a depreciating asset like a car. Instead, consider doing some prep work ahead of time to secure a low-cost auto loan. With good credit and sharp negotiating skills, you can get a good deal on a car without putting your home or the wealth you’ve built up at risk.
