Home equity loan may help you buy a car

It’s expensive buying a car; they price of the average automobile now seems to be about $20,000, and the price has climbed considerably faster than inflation over the years. Of course, we now have air bags, antilock braking systems, and MP3 players, we get more car than we used to. Still, they are expensive, and that means we have to find a way to pay for them. Given that you will have to also pay for car insurance, you will want to find an affordable way to pay for the car.

An auto loan is the traditional way to pay, and such financing is easily obtained through either a dealer or a lending institution, such as a bank or credit union. The interest rates tend to be somewhat higher than for a mortgage, but much lower than for credit card loans. Even so, a good auto loan might cost about 9% interest today. Is there a better way to finance a car purchase?

There might be. One possible solution would be to leverage the equity in your home. A home equity loan is a loan that uses the portion of your home that you have paid for as collateral. If you have a home that is valued at $150,000 and you owe $100,000 on it, you have $50,000 in equity. A bank or mortgage company would be willing to lend you money against that $50,000 of your home that you own. 

There are advantages to borrowing that way. Interest on car loans is not tax deductible. But you can, in many circumstances, deduct the interest on a home equity loan from your Federal income tax. That effectively lowers the interest rate. If you are in the 25% tax bracket, it’s like getting a 25% discount on your interest rate. 

An additional bonus is that the loans are cheaper than car loans. You might get a home equity loan for a rate that is perhaps two points cheaper than a car loan, particularly if you have a good credit score.

There are some downsides to consider, however. With a car loan, your car is the collateral for the money you obtain from the lender. If you fail to make your monthly payment, your car could be repossessed. With a home equity loan, you are theoretically putting your house at risk. Your loan is not tied to your car, it is tied to your house. Failure to pay on your car could lead to foreclosure.

Another issue to ponder is how long you should pay. With a home equity loan, repayment terms of ten years are common. That would certainly lead to an affordable car payment, but is it wise to pay for a car over ten years’ time? Probably not, unless you intend to drive the car for that long. If not, you should arrange for a loan that covers the length of time that you expect to own the car.

Aside from those caveats, it can often make good financial sense to take out a home equity loan to pay for a car.

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