A home equity loan is a way of borrowing money against the value of your home. These loans are a type of consumer debt in which a lender (normally a bank or a credit union) will lend you money at low interest rates in exchange for you offering your house as collateral. Home equity loans often have long payback periods, similar to a mortgage, and so are sometimes referred to as second mortgages. Just like a first mortgage, your house is at risk if you fall behind on the payments.
You can use the money from a home equity loan to buy anything you’d like, including a car. Since these loans have low interest rates and low monthly repayments, this can seem like a good deal. However, it’s generally not a good idea to use a home equity loan to finance a car purchase. In this article, we’ll explain why.
Key Takeaways
- Cash from a home equity loan can be used for anything. Generally, it’s unwise to use it for a car purchase.
- Home equity loans can take decades to pay off, but cars quickly lose value. You would then be paying for your car long after it’s substantially depreciated in value.
- Try to improve the terms on a standard auto loan before using home equity to buy a vehicle.
Using a Home Equity Loan To Buy a Car
Home equity loans can be a good way to borrow money for the long term. These loans often have low interest rates because they are secured loans: The bank is not taking much of a risk. After all, if borrowers can’t keep up with loan payments, the bank can claim their home. They also have long repayment terms (sometimes decades), and correspondingly low monthly payments. You can use the money you receive from a home equity loan in any way you like—after all, it’s the money you’ve previously paid on your mortgage.
That includes buying a car. At first glance, taking out a home equity loan to buy a car might seem like a good deal. You are using money you’ve already paid on your mortgage, and home equity loans can have very low monthly payments in comparison to auto loans. That’s especially true if you don’t have great credit.
However, using a home equity loan to buy a car is normally a pretty bad idea. This is because you are taking money out of a long-term, fairly secure investment (your home equity) and using it to buy a depreciating asset—a car. Cars start to lose value the day they’re bought and will generally be worth a lot less after a decade.
If you use a home equity loan to buy a car, you may quickly owe more on the loan than the car is worth. You may also be paying off the loan long after you’ve sold the car. Though your monthly payments might be very low, that also means you’ll be paying off the loan for a long time. Perhaps worst of all, however, is the fact that your house will be at risk for this entire period: If you fall behind on your loan repayments, the bank can foreclose on you and you could lose your home.
New cars can lose about 60% of their value over five years. Home equity loans generally have repayment terms much longer than this—so if you use a home equity loan to buy a car, you might be paying off the loan for years after your car has lost its value.
The Alternatives
Though using a home equity loan to buy a car is normally a bad idea, for some people it might be the only viable way to afford a vehicle. This is particularly true if your credit score isn’t great, because in that case, the terms you are offered on standard auto loans can be very expensive. However, the drawbacks to using a home equity loan to finance a car purchase are such that it’s worth trying to make a regular auto loan more affordable before you turn to your home equity.
There are a couple of ways that you can get a better deal on an auto loan:
- Improve your credit score. The auto loan rates you are offered depend a lot on your credit score. If you have a credit score below 740 (which is regarded as “good”), spend a few months working on your credit score before applying for an auto loan. It might make a big difference to the terms you are offered.
- Increase your down payment. Lenders will give you a better deal if you are able to put even a little more cash down at the beginning of your loan term. A bigger down payment will also mean you’ll be borrowing less, further reducing your monthly costs.
- Get pre-qualified. Approach lenders before you decide on a car, so you can understand how much you can afford to spend. Having financing secured in advance also provides more bargaining leverage with car dealers and might get you a better deal.
It may be that even after you’ve worked through these tips, an auto loan is still too expensive for you. In that case, it’s possible to use your home equity to buy a car, but you should regard this as a last resort.
Can I Use a Home Equity Loan To Buy a Car?
Yes. A home equity loan can be used any way you like. But it’s generally considered best to use it for a home improvement project and not a quickly depreciating asset like a car.
Why Would I Use a Home Equity Loan To Buy a Car?
Home equity loans generally have low interest rates and low monthly payments. This can make them look a lot cheaper than an auto loan. This is particularly true if you don’t have great credit because that can make auto loans very expensive.
Should I Use a Home Equity Loan To Buy a Car?
Generally, it’s a bad idea. Cars lose their value quite quickly, whereas your home is likely to increase in value. Home equity loans have long repayment terms, meaning you might be paying off your loan for longer than you have the car you bought with it and may end up paying far more for it over the long term.
The Bottom Line
You can use the cash from a home equity loan to buy anything you’d like—after all, it’s your money. However, it’s generally not a good idea to use it to buy a car. That’s because home equity loans can take decades to pay off, but cars quickly depreciate in value. This can mean that you’ll be paying for your car long after it’s lost all of its value. It’s better to try to improve the terms you can get on a standard auto loan before you consider using your home equity to buy a vehicle.