Can You Use a Home Equity Loan to Buy a Car?

There are several ways to finance the purchase of a new or used car, including using a home equity loan.

While buying a car with a home equity loan has unique benefits, there are also a number of downsides (and potential risks) to consider. Before you use a home equity loan to buy a new vehicle, consider comparing loan options from auto lenders below.

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What Is a Home Equity Loan?

Home equity loans allow 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 your mortgage balance. The more equity you have, the more money you can borrow.

However, you usually cannot borrow your entire equity balance. Instead, your lender will authorize a loan amount that is approximately 80 percent of the appraised value of your home or a portion of its combined loan-to-value ratio. Like all loans, your interest rate and other loan terms will depend on your credit score and similar factors.

Home equity loans come in two types:

Fixed Interest Rate Loans

A fixed-rate home equity loan gives the borrower a one-off. Traditional home equity loans have a set repayment term, much like conventional mortgages. You make fixed monthly payments that cover principal and interest over a set period, usually five to 15 years.

Home Equity Credit Line (HELOC)

HELOC is a home equity line of credit. Think of it like a revolving credit card, where you can withdraw your available balance whenever you need it. After you pay back, you can use it again and again.

Your lender will determine the term, and if you choose this type of home equity loan, expect the bank to charge a variable interest rate. The withdrawal period is usually between five and 10 years, while subsequent payment periods can be extended by a decade or more.

Can You Buy a Car with a Home Equity Loan?

You can use a home equity loan for any purchase, including a new or used car. However, using an equity loan to buy a car is a much different process than getting car financing from a car dealer.

This often involves appraising your home to find out exactly how much equity you have. Also, there is a limit to the amount of money you can spend, which will affect the number of cars you can afford.

Advantages of Using Your Home’s Equity to Buy a Car

Your home’s equity can be an easy source of cash. Plus, home equity loans come with low interest rates and the possibility of a tax deduction, making them an attractive option for car buyers. Here are some of the advantages of buying a car with a home equity loan:

Flexible Payment Terms

The repayment terms for most car loans range from 24 months for a used car to 84 months for a new model. Home equity loans give you a much longer timeframe to pay off debt. Most banks will extend the term to between 10 and 15 years or more. You can also usually pay off your home equity loan early without penalty, which isn’t the case with every auto loan.

Low Monthly Payments

Because home equity loans usually have a longer repayment period, you’ll pay less each month than you would with a car loan. With multiple new car monthly payments in excess of $1,000, saving that money can make a big difference in your financial situation.

Lower Interest

Most lenders charge lower interest rates on home equity loans because they are secured against your home. If you have an excellent credit score, you may be able to qualify for rates under 3 percent.

Disadvantages of Home Equity Loans

Taking out a home equity loan to buy a car seems like a good idea, especially if you have a steady income and a large percentage of equity in your home. However, using a home equity loan has drawbacks. Here are a few things to consider before you choose this option:

Foreclosure Risk

When you take out a home equity loan, your home is used as collateral. That means if you default on your loan, the lender can foreclose on your home. Using your property as collateral solely to buy a vehicle is a risky choice, especially when safer methods are available.

You Can Struggle to Sell Your Home

If you need to sell your home, you could end up with a losing sale. In particular, this can be a problem if you need to sell your home before you can repay a home equity loan. If your mortgage is reversed and your home’s value decreases, it could prevent you from selling your home altogether.

You Lose Available Equity

When you use your home equity to buy a vehicle, you no longer have the option of using equity for larger, more important purchases. For example, if you need to get money fast to cover an unexpected medical bill, you will no longer be able to leverage your home equity to access cash.

Adding Depreciation Cost

While the market value of your home is likely to increase, the value of your car will not. Your new vehicle will depreciate quickly and will lose about 20 percent of its value during its first year. When you buy a car with a home equity loan, you will be paying for the vehicle long after it has dropped in value. Remember the real estate market fluctuates too. So if your home’s value has decreased, you could owe the bank more than it’s worth.

Longer Loan Period

While the benefit of a home equity loan is a longer repayment period, this extended timeframe can also extend the life of your car. For example, if your car loan is $20,000 and it takes you 12 years to pay it off using a home equity loan, you probably won’t be driving your car at the end of that 12 year period.

Higher Interest Expenses

Longer repayment terms with home equity loans also mean paying more money in interest. If you choose a traditional car loan with a shorter repayment period of three years or less, you’ll pay significantly less interest on the vehicle.

The Temptation to Spend More

If you choose to take out a HELOC rather than a one-time, fixed-rate home equity loan, you may be tempted to buy a car you can’t really afford. Resist the urge to spend your equity balance when you get it back. Otherwise, you run the risk of accumulating more debt and jeopardizing your home.