You can use a home equity loan for just about anything, including buying a car. But there are some downsides to consider.
If you’re in the market for a new or used car, then you’re probably thinking about how you’ll pay for it. In 2022, the average used car price is more than $28,000, and the average used car price is nearly $20,000 higher. As a result, most buyers turn to loans.
Contrary to popular belief, a traditional car loan isn’t the only option available when it comes to financing a car. Some borrowers may also choose to use a home equity loan. While there are advantages to going this route, it’s also important to proceed with caution, as the downsides are severe.
Can you use a home equity loan to buy a car?
The short answer is that yes, you can use a home equity loan to buy a car. Rather than being secured by your car as most car loans are, the loan is secured by your home.
Relying on your home equity instead of an auto loan to buy a car offers several advantages, including lower interest rates, longer loan terms, and lower monthly payments. However, as we’ll discuss later, there are also some major downsides to consider.
How home equity loans work
A home equity loan is a term loan that allows you to pull equity from your home. This type of loan — often known as a second mortgage — is secured by your home. In other words, your home serves as collateral for the loan, and if you fail to make your payments, your home equity lender could foreclose on the property.
As a term loan, home equity loans generally have set principal amounts, fixed interest rates, set monthly payments, and a set payment term. The loan amount you can borrow and the interest rate and term available to you depends on the amount of equity you have in your home, your creditworthiness, and the lender you choose to work with.
In most cases, lenders allow you to borrow up to 80% of the equity in your home. For example, if you have a home worth $300,000, you could borrow up to $240,000 at any given time. But remember that your current mortgage counts toward that. So if you have a mortgage with a balance of $200,000, then you can most likely only borrow up to $40,000 with a home equity loan.
Uses for home equity loans
One of the perks of a home equity loan, as well as other types of home equity financing, is that you can use the money for anything. Many people use home equity loans to pay for home renovations or consolidate high-interest debt. They can also be used for large purchases such as a child’s education or a new vehicle.
Not only can you use a home equity loan for anything, but what you plan to use the money for doesn’t affect the interest rate available to you. Because the loan is secured by your home and is also based on your creditworthiness, the lender’s risk doesn’t change based on the purpose of the funds. That being said, it’s still smart to compare home equity loan lenders before agreeing to any one plan.
Pros and cons of using a home equity loan to buy a car
Using a home equity loan to buy a car comes with several advantages, but it also has some major downsides that make it worth reconsidering.
Here is a list of the benefits and the drawbacks to consider.
- Lower interest rates. Mortgages tend to have some of the lowest interest rates on the market. And while the rates on a second mortgage may not be quite as low, they’re often considerably lower than the rates available on other types of loans.
- Longer loan terms. Lenders often only allow payment terms of up to five years for a vehicle. But in the case of a home equity loan, you could have a payment term of ten years to repay your loan.
- Lower monthly payments. Because of the reduced interest rates and longer terms, home equity loans often offer lower payments than other forms of financing.
- Lost equity in your home. When you use your home equity to buy a car, it means you have less equity in your actual home. This could be a problem if you want to sell the home or if property values decline in the future.
- Risk of foreclosure. Because the home equity loan is secured by your home, failing to repay the loan could result in losing your home.
- Closing costs. Like other home loans, home equity loans often require closing costs, which you don’t always have with auto loans.
- Longer loan terms. Yes, longer loan terms are both a pro and a con of home equity loans. It’s nice to lower your monthly payment by stretching out the payment term, but it also means you’re in debt longer than necessary.
Home equity loan vs. auto loan
When you’re buying a car, a home equity loan or an auto loan are two of the options available to you. They both have some things in common. For instance, they are both secured loans with (usually) fixed interest rates and set repayment terms. But there are also some important differences.
First, home equity loans and auto loans are secured by different collateral. An auto loan is secured by your car, meaning if you fail to make your payments, your lender could repossess your car.
But a home equity loan is secured by your home, meaning a lender could foreclose on your home if you default. While neither scenario is optimal, most people would much rather lose their car than their home.
Another difference between home equity loans and auto loans is the interest rate and repayment terms. Because they are secured by your home equity, home equity loans have lower interest rates, and often offer repayment terms ranging from five to 20 years. Auto loans generally offer higher interest rates and lower repayment terms, resulting in higher monthly payments.
When you’re choosing between the two, you’ll have to weigh the pros and cons of each. Yes, the lower interest rate and lower monthly payments are a great perk of home equity loans. But is it really worth putting your home on the line?
Other ways to buy a car with home equity
If a home equity loan isn’t your preferred financing option, there are fortunately alternative methods to choose from.
Home equity line of credit
A home equity loan is one way to buy a car with your home equity, but it’s not the only way. Another option is a home equity line of credit (HELOC).
A HELOC is a type of revolving debt, similar to a credit card. You have a set loan amount of money you can borrow, and you can use that line of credit again and again as long as you repay it. And like a credit card, you only have to repay the portion of the credit line you’ve actually used.
An alternative to home equity loans and HELOCs is a cash-out refinance. With a cash-out refinance, you replace your existing home loan with a new one. Your new loan has a new term, a new interest rate, and new monthly payments.
A cash-out refinance differs from other refinance loans because instead of borrowing the same amount as your current mortgage balance, you borrow more and take the excess in cash. You can then use that extra cash for any purpose, including buying a car.
A cash-out refinance could have other benefits. If current interest rates are lower than your current mortgage rate, you could save money on your mortgage. But if interest rates are higher, you end up with a higher interest rate on your entire mortgage solely for the purpose of getting the cash to buy a car.
Shared equity agreements
Home equity agreements, another name for shared equity agreements, are a relatively new home equity financing product that is an attractive option for homeowners with a high debt-to-income ratio or who don’t have a great credit score.
Shared equity agreements allow you to unlock your home equity without charging interest or monthly payments. They are also easier to qualify for than traditional home equity products, such as home equity loans and HELOCs. See how much you could get today for a share of your home’s future appreciation.
How to buy a car with a home equity loan
Are you considering using a home equity loan to buy a car? Here’s how to get started:
- Determine how much home equity you have. You can easily figure this out by subtracting your current mortgage balance from the assessed or appraised value of your home. Remember, you can usually borrow up to 80% of your home’s value.
- Shop around. One of the perks of a home equity loan is the low interest rate, but you want to make sure you’re getting the best deal. Get quotes from multiple lenders before committing to one.
- Apply for the loan. To qualify for a home equity loan, you’ll have to meet your lender’s requirements when it comes to your credit score, debt-to-income ratio, and more. Read each lender’s requirements and make sure you have good credit before applying so you don’t have an unnecessary hit on your credit report.
- Receive the money. The entire home equity loan process can take anywhere from just a couple of weeks up to a month. Once your loan has been approved and you’ve signed the paperwork, you’ll receive the money within three business days. From there, you can bring it to your car dealer and use it to buy a car.
Can you use a home equity loan for anything you want?
Yes, one of the perks of a home equity loan is that you can use the funds for any purpose. While the purpose doesn’t matter, remember that you’ll have to pay back those funds with interest.
Does a home equity loan allow you to borrow money anytime?
A home equity loan is an installment loan, meaning it only allows you to borrow money once. For a home equity financing tool that allows you to borrow money again and again, consider a HELOC.
How much equity do you need to borrow against?
Lenders generally allow you to borrow up to 80% of your home’s value with equity financing, so you’ll need to have enough equity in your home to be under that threshold.
Can I use equity as collateral for a loan?
Yes, you can use your home’s equity as collateral for a loan using a home equity loan, HELOC, or cash-out refinance.
- A home equity loan allows you to take equity from your home and use the funds for any purpose, including buying a car.
- Home equity loans have some benefits, but also serious risks, including the chance of losing your home if you don’t make your loan payments.
- While home equity loans might be the right choice for some borrowers, others are better off using a standard auto loan to buy a car.
- If you’re considering using an auto loan to buy a car, be sure to shop around for the best rate.
View Article Sources
- A Consumer’s Guide to Mortgage Refinancings — Federal Reserve Board
- Home Equity Loans and Home Equity Lines of Credit — Federal Trade Commission
- Home Equity Loan vs. Line of Credit: Which Should You Choose? — SuperMoney
- How Long Does It Take to Get a Home Equity Loan? — SuperMoney
- LoanDepot Home Equity Loans: Are They Right For You? — SuperMoney
- Ultimate Guide to Auto Equity Loans — SuperMoney
- The Best Shared Equity Alternatives to a Home Equity Loan | June 2022 — SuperMoney
- Best Home Equity Loans | June 2022 — SuperMoney
Erin Gobler is a Wisconsin-based personal finance writer with experience writing about mortgages, investing, taxes, personal loans, and insurance. Her work has been published in major outlets, such as SuperMoney, Fox Business, and Time.com.