There are many ways to finance a new or used car purchase, including using a home equity loan.
While buying a car with a home equity loan has its advantages, there are also many disadvantages (and potential pitfalls) that think about it. Before you take out a loan to buy a new car, consider comparing loan options from the car lenders below.
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What is a Home Loan?
A home equity loan allows you to borrow money against the equity in your home, using your property as collateral. Simply put, equity is the difference between the market value of your home and the balance of your mortgage. The more money you have, the more money you can borrow.
However, you don’t usually borrow your entire equity balance. Instead, your lender will approve a loan amount of approximately 80 percent of the appraised value of your home or a portion of its combined loan-to-value ratio. As with all loans, your interest rate and other loan terms will depend on your credit score and other factors.
There are two types of home loans:
Pay off loans to give borrowers a lump sum. Conventional home loans have a repayment period, just like a traditional mortgage. You make regular, fixed monthly payments that cover both principal and interest over a specific period of time, usually five to 15 years.
Home Equity Line of Credit (HELOC)
A HELOC is a home equity line of credit. Think of it like a credit card, you can draw on the available balance whenever you need to. Once you pay it back, you can use it over and over again.
Your lender will set the time frame, and if you opt for this type of term loan, expect the bank to offer a variable interest rate. The draw period is usually between five and 10 years, while the next repayment period can extend ten years or more.
Can you buy a car with a home loan?
You can use a home equity loan for any purchase, including a new or used car. However, using a personal loan to buy a car is a very different process than getting car financing from a car dealership.
This often involves an inventory of your home to determine exactly how much you can afford. In addition, there is a limit on the amount of money you can take out, which affects the size of the car you can afford.
Advantages of using your home to buy a car
Your home equity can be an easy source of income. In addition, home loans come with low interest rates and are tax deductible, making them an attractive option for car buyers. Here are some of the advantages of buying a car with a home equity loan:
Flexible Repayment Terms
Repayment of most loans ranges from 24 months for a used car to 84 months for a new model. A home equity loan gives you a very long time to repay the loan. Most banks will extend terms between 10 and 15 years or more. You can also often pay off a home loan quickly without penalty, this is not the case with all auto loans.
Low Monthly Payments
Because home loans usually take longer to pay off, my monthly payments are lower than car loans. Among others new car monthly payment more than $1,000, saving that money can make a big difference in your financial situation.
Most lenders offer low interest rates on home equity loans because your home is secured. If you have a good credit score, you may be able to qualify for a rate as low as 3 percent.
Disadvantages of Home Loans
Taking out a car loan can seem like a good idea, especially if you have a steady income and a large percentage of your home equity. However, using a home equity loan has its drawbacks. Here are a few things to consider before you choose this option:
When you take out a home loan, your home is used as collateral. This means that if you do not pay the loan, the lender can foreclose on your home. Using your property as the only guarantee to buy a car is a risky decision, especially when there are other safe ways to do it.
You may struggle to sell your home
If you need to sell your home, you may end up losing the sale. In particular, it can be a problem if you need to sell your home before you repay the home equity loan. If you have defaulted on your mortgage and reduced the value of your home, it may prevent you from buying the entire home.
Equity Opportunities Available
When you use your home equity to buy a car, you no longer have the option of using the equity for a bigger, more valuable purchase. For example, if you need quick access to cash to pay for emergency medical bills, you will no longer be able to use your home equity to get cash.
As the market value of your home increases, so does your car. Your new car will depreciate quickly and will lose about 20 percent of its value in the first year. When you buy a car with a home equity loan, you pay off the car after it depreciates. Also remember that the real estate market fluctuates. So if you lower the value of your home, you may end up owing the bank more than the value.
Long Term Loans
While a home loan benefit is a longer repayment period, this extended period can also extend beyond your car. For example, if your car loan is $20,000 and you spend 12 years paying it off using a home loan, you may not drive your car at the end of that 12 years.
The longer the repayment period with a home loan, the more money you pay in interest. If you chose a conventional car loan with a short repayment period of three years or less, the interest rate on the car will be much lower.
Temptation to Overspend
If you choose to take out a HELOC instead of a single, home equity loan, you may be tempted to buy a car you can’t afford. Resist the urge to spend your equity balance while you earn it back. Otherwise, you’ll hinder debt collection and put your home at risk.
Director of Finance & Insurance
Elizabeth Rivelli is a freelance writer with over three years of experience covering personal finance and insurance. He has extensive knowledge of various insurance lines, including auto insurance and property insurance. His byline has been featured in several online financial publications, such as The Balance, Investopedia, Reviews.com, Forbes, and Bankrate.