Buying a home gives you an opportunity to earn equity; and when you have equity, there’s the option of getting a home equity loan. This type of loan uses your home’s equity as collateral and you can borrow up to a percentage of your equity. You’ll receive a lump sum, which can be used to pay off credit card debt, plan home improvements or cover the cost of educational expenses. But these aren’t the only uses for your equity. If you’re in the market to buy a car, you can also use a home equity loan to purchase a vehicle with cash.
There's no rule that prevents you from buying a car with a home equity loan. But although this approach has been taken by some homeowners, it’s not always the best move. There are a few things you need to consider before buying a car with a home equity loan.
Pros of Using a Home Equity Loan for a Car Purchase1. Flexibility to pay off the car over a longer term
When you apply for an auto loan through a bank, most lenders allow terms between 36 months and 60 months. Depending on the bank, you can stretch the auto loan as far out as 72 months or 84 months. A five-year term is doable for most people. But if you need a longer term, you’ll have to consider other alternatives.
A home equity loan, on the other hand, typically has a repayment term up to 10 to 20 years. Although you wouldn’t finance a car for 10 years (or at least you shouldn’t), a home equity loan gives you the option of paying off the car over an extended period if you can’t find an auto lender to stretch your term beyond five years. Be aware that the longer it takes to pay off a car, the more interest you’ll pay.2. Interest on a home equity loan is tax-deductible
Another pro for using a home equity loan to buy a car is that interest on these loans is tax-deductible. Regardless of whether you use funds for home improvements, debt consolidation or a car purchase, you can write off the interest payments and save on your taxes.
Unfortunately, you don't get any tax breaks when you finance a car – unless, of course, you use the car for business. In this case, you can write off car expenses (mileage, repairs, property taxes, etc.) as a business expense.
Cons of Using a Home Equity Loan for a Car Purchase1. Higher interest rates with a home equity loan
The interest rate with a home equity loan is typically lower than the interest rate on a personal loan, and higher than the interest rate on a first mortgage. But when you compare home equity loan rates with auto loan rates, you’ll find that auto loan rates are usually cheaper—especially if you have good credit.
When you apply for a home equity loan with good credit, the lender might charge a competitive interest rate as low as 5% or 6%. This is impressive, but the rate doesn’t compare with low rates offered by auto lenders. Well-qualified buyers can get an auto loan with rates as low as 2% to 3%. And if buying a new car with excellent credit, some auto financing companies offer 0% interest for 60 months.2. You can get a car with no down payment
Nowadays, it’s practically the norm to purchase a car with no down payment—even with less-than-perfect credit. This means you can buy a car and pay absolutely nothing out-of-pocket. A home equity loan, on the other hand, is a type of mortgage. And just about every mortgage has closing costs. Granted, the closing costs will be cheaper than the costs of getting a first mortgage, but you’ll still need cash on hand to complete the transaction.3. You’re gambling with your home
Since a home equity loan uses your equity as collateral, you're basically using your house as collateral for a car. Using equity to pay for a depreciating value like an automobile is dangerous. The value of your car may depreciate faster than you’re able to pay down the home equity loan.
You also need to consider the financial repercussions if you're unable to make your home equity loan payments. Anything can happen like a job loss or an illness that prevents working. If you use a home equity loan to purchase a car, and then default on this home equity loan, you don’t lose your car, you lose your house. This is because a home equity loan is a junior lien on your property. If you don't repay the lender that approved the second mortgage, this lender can foreclose.
Thinking about buying a car with a home equity loan? Make sure you understand the pros and cons of this decision. Then, get your up-to-date credit score in order to know where you stand!