Can you Use Home Equity to Buy a Car?

If you have been paying your mortgage for some time, you must have built up equity in your house. Lenders will require at least 20 percent equity before giving you the loan. You can use the money to fund projects like house renovation, consolidating debt, becoming a business owner, or education.

While you might have considered using your home equity to buy a car if you don't have money to pay upfront, is it a good idea? What are the dangers of using your home equity to buy a car? Here is everything you need to know to help you determine whether using home equity to purchase a vehicle is your best option.

What is home equity?

Home equity is the value of ownership that a homeowner has in their home. It represents the difference between the home's current market value and the outstanding balance of any loans secured by the house. In simpler terms, it's the portion of the property that you truly "own" in financial terms.

Using your home equity to borrow money is a perfect way to tap into your house's value without selling it. After you make mortgage payments for some time and the house's value appreciates the share of the home you own (equity) increases. You can use this share as collateral to get a loan.  

On average, lenders require homeowners to have at least 20% home equity before applying for a second loan. You can spend the money on whatever you want, but using it for home improvement projects is best.

Can you use home equity to buy a car?

Yes. You can use your home equity to buy a car and anything else. The home equity is the portion of your property that you own, so you can use it as collateral to get financing. In addition, because it's a second mortgage, the lender already knows your repayment habits, and the home is the collateral, so the debt is secure.

The interest rates may be lower than you would get with a car loan. Moreover, the repayment period is long (5 -20 years), so the monthly payments will also be lower. Using your home equity to buy a car is ideal if you have a lower credit score and can't access auto loans with low-interest rates.

However, should you use home equity to buy a car? Financial experts advise against using home equity to buy a car. This is because your home equity is a secure investment that could be used for income-generating projects. Using it to buy a vehicle puts your house at risk of foreclosure if you default on the payment. Moreover, a car immediately starts losing value once you take possession. That means although the loan has low interest rates, you will be paying for an asset that is losing value. Ultimately, you will owe more on the loan than the vehicle is worth.

But it's not all bad; you can use home equity to buy a car, especially if you have a low credit score. However, you must weigh the pros and cons.

Pros of using home equity to buy a car

• Home equity loans often have lower interest rates than traditional auto loans. You could save money over the life of the loan.
• Monthly payments are lower because you repay the loan over an extended period.
• Potential tax benefits if the interest paid is tax-deductible
• With home equity loans, you can borrow larger amounts than conventional auto loans, allowing you to buy a higher-priced vehicle or cover additional expenses.

Cons of using home equity to buy a car

• You risk losing your home if you default on payment
• You will pay more interest because you are paying the loan for an extended period.
• You will lose money in the long run because you are paying interest for an asset that is losing value.
• You won't be able to tap into your home equity if you get into a financial emergency.

How to use home equity to buy a car

You can use your home equity to buy a car in several ways. They include;

Home equity loan

A home equity loan allows you to borrow money using the equity in your property as collateral. The loan has a fixed interest rate and a structured repayment plan that ranges from 5 to 20 years. When your application is approved, you will receive a lump sum. The home is the security; if you fail to repay, the lender could foreclose on it. With a home equity loan, you can borrow about 80% to 85% of your equity (house value minus your mortgage balance.)

Home equity line of credit (HELOC)

A HELOC is an open-end credit line using your home equity as collateral. It works like a credit card; you can draw funds up to a predetermined limit. Minimum monthly payments cover interest, but you can pay down the principal.

Like in a home equity loan, your equity is the value of your home minus the mortgage balance. That means you can borrow against your equity throughout your draw period (usually 10 years) to finance whatever you want, including buying a car. However, the repayment period (usually 20 years) starts at the end of the draw period.

Cash-out refinancing

Cash-out refinancing is a mortgage refinancing option where you replace your existing mortgage with a new one by borrowing more than the current loan balance. You will receive the difference between the new loan amount and the existing mortgage in a lump-sum payment, and you can use it to buy whatever you want.

For instance, assume your house is worth $400,000, but your mortgage balance is $200,000. If you deduct the 20% equity you need to maintain in the home, you could take a cash-out refinancing of $320,000, pay the mortgage balance of $200,000, and go home with $120,000.

Alternative financing for a car loan

Before using your home equity to purchase a car, think about the long-term implications. How will the move affect your future financial goals? Nonetheless, you could use either of the following ways to get a car.

Auto loans

This a loan you borrow to purchase a vehicle. You can get auto loans through dealer financing or from a reputable online lender, bank, or credit union. The car is the collateral, so you can lose it if you default. The interest rates are favorable because the loan is secure and could even be better if you have a good credit score.

Personal loans

A personal loan is money borrowed to cater to your personal needs, including buying a car, investing, or paying for a vacation. Personal loans can be secured or unsecured. Unsecured personal loans tend to have higher interest rates.

Lease

You could consider leasing if you can't afford to pay for a car outright. Leasing allows you to drive the vehicle of your choice for a predetermined monthly payment for an agreed-upon amount of miles and time.

Before using the above means to get a car, consider the pros and cons. And if you determine buying a vehicle via home equity is better, go ahead and buy the car.

Bottom line

Whether to use home equity to buy a car will come down to your personal situation. On the one hand, it could help you purchase a vehicle even when your credit score is low; on the other, you risk a secure investment as you could lose it if you default.

Start by evaluating your situation. Do you really need a car? Can you get alternative financing? If you really need the car and can't get alternative funding, you could use home equity to buy the car. Remember to pay the loan as required so as not to lose your home.