If you’re looking to buy a car, the traditional choice for financing is an auto loan, but it’s also possible to finance your vehicle using a home equity loan.
Using this approach, however, involves vastly different considerations than an auto loan. To begin with, your home is the collateral for a home equity loan, which can be a risky move if you fall behind on repayment. In addition, there may be closing costs to pay.
But home equity loans also have some benefits. They typically offer more favorable interest rates than auto loans and more flexible repayment terms, with repayment stretched out as long as 10 to 15 years.
Here’s how to determine whether using a home equity loan to buy a car is the best option for you.
Should I use my home equity to buy a car?
Buying a car using home equity is a high-risk financing option that should be avoided if possible. While a traditional car loan is secured by the car you purchase, a home equity loan is secured by your home. That means the lender can foreclose on your home if you can’t repay a home equity loan.
The repayment terms are also very different between the two types of loans. With a home equity loan, the repayment timeline can be as long as 10 to 15 years or more. The stretched-out timeline means your monthly payments are likely to be much lower than they would be with an auto loan.
However, it’s important to consider that a car’s true market value depreciates at an accelerated rate. According to Edmunds, a new car loses 23.5 percent of its value after about one year and 60 percent in the first five years.
If you buy a car using a home equity loan, which can offer repayment terms of a decade or more, you’ll be paying for a vehicle that’s not even worth that loan amount anymore. A longer repayment timeline will also mean that you’re paying more interest overall for the purchase than you would with a shorter auto loan.
Pros and cons of using a home equity loan to buy a car
Although a home equity loan is one option to buy a car, there are several factors to consider before going this route. Here are some of the biggest benefits and drawbacks of buying a car using a home equity loan.
Most car loans are for a set duration of three to seven years, but a home equity loan typically gives you a longer period to repay, generally between 10 and 15 years and sometimes longer. With a home equity loan, you can also typically pay the loan off early, which is not the case with many auto loans.
Lower interest payments
Home equity loans typically have lower interest rates than auto loans, which could help if your budget is tight. If you have good credit, you may be able to find home equity loans with rates as low as 3 percent.
Longer repayment terms
The longer repayment timeline of a home equity loan will lower your monthly payments, but the loan may also outlive your car. This could result in you still paying your home equity loan for the old vehicle while financing a new vehicle.
Decreased home equity
Using your home equity to finance a car decreases the total amount of equity you have available in your home. This can be a problem if you need to sell your home before you’ve paid the loan back. That could cause you to become upside down on your mortgage if your home value decreases to the point that you owe more on your mortgage and the home equity loan than your house is worth.
Some home equity loans incur up-front closing costs in addition to the interest you’ll pay over the loan term. This means that even if you get a lower interest rate than you would with an auto loan, a home equity loan could cost you more money.
Risk of foreclosure
If you’re unable to keep up with payments, the lender can sell your home to recoup the debt that you owe.
It is possible to use your home equity to take out a loan for a car, and you may get a better interest rate on your loan by taking that route. However, before you move forward, consider the risks of using your home as collateral and the drawbacks of choosing a longer loan. You may not want to carry debt any longer than you have to, especially for a car.