Don't Finance Your Car With Your Home Equity Loan

Maryland consumer attorney Sonya Smith-Valentine warns not to use a home equity loan to purchase a car. Her reasoning makes sense. When you use a home equity loan, you pay for the for many years longer than you would with a regular car loan, multiplying the interest you end up paying.

The same is true for rolling a new car into your refinance. If you refinance your house and take out enough money to purchase a car, for example, you pay for it over the life of the home loan, which is probably 30 years. Even though your home loan interest rate is lower than a car loan interest rate, you will pay more for the car by rolling it into your home loan.

Get a car loan instead. Or, if you have already done this, Pay more than the minimum monthly payments so that your principal is restored more quickly. SAM GLOVER

(Photo: Ben Popken)

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  1. JustAGuy2 says:

    This is actually bad advice for a disciplined person. If you buy your car using a home equity loan or line of credit, you can

  2. JustAGuy2 says:

    This is actually bad advice for a disciplined person. If you buy your car using a home equity loan or line of credit, you can borrow at much lower cost than with a typical car loan. Certainly, you need to be disciplined enough to make the car payments you would have made, had you used a typical car loan, but if you do so, you’ll end up paying a lot LESS in after-tax interest, as well as paying the car off faster (since more of your payment will go to paying off the balance of the loan.

  3. bricko says:

    The same is true of building a new home. NEVER roll in the costs of appliances or HVAC components. You will be paying for that refrigerator or dish washer or central air system for 30 years. Far after you have bought NEW ones to replace the ones you are now using.

    Get a short term loan if necessary. Tell the bank what your want to do…they should applaud you. Heck even putting them on your Sears card and paying bad interest would be better than paying for 30 years while you go through 2 or 3 sets of appliances.

  4. rbb says:

    I disagree. It’s not the loan that causes the problem, it is the borrower who gets in over thier heads by not understanding the loan terms. I have financed my last three vehicles using my home equity. The 2002 was paid off in 3 years. The 2005 will be paid off in a few months. The 2007 will be paid off in less than 4 years.

  5. FINANCE101 says:

    If you are saavy you would borrow against your home equity for all borrowing needs. And you would never borrow otherwise.

    Of course, many people are not saavy.

  6. iLoveDebt.com says:

    Another option would be to just save-up and buy the car with cash. That would give you the most savings with regards to paying interest :)

  7. Brilluminati says:

    Her reasoning is not completely accurate.

    Most Home equity loans are in fact HELOC’s or home equity lines of credit.

    These are actually secured credit lines secured by the equity in your home. These can be more beneficial because as the line is paid down, the available credit is incresed – just like a credit card.

    If used responsibly, the HELOC could be used for years, to purchase multiple cars. With car loans there are finance and dealer fees that you could avoid if you’re paying “cash”.

  8. esqdork says:

    I point out that the interest from a home loan is deductible while the interest from a car loan is not. Also, the borrower can certainly take out a home loan for a shorter duration like 5, 10 or 15 years and, if there is no prepayment penalty, the borrower could always pay it off early.

    Just saying …

  9. sizer says:

    I paid off my car loan with a home equity loan. I got a lower rate and I got to deduct the interest. Of course I also paid it off in 3 years, just like I would have done with the car loan.

    If you actually read the entry, she does cover this with the caveat: ‘If you don’t have the discipline to pay more than the minimum payment on the home equity loan, it’s not a good idea to purchase a car this way.’

  10. Trackback says:

    [Consumerist crosspost] Maryland consumer attorney Sonya Smith-Valentine warns not to use a home equity loan to purchase a car. Her reasoning makes sense.

  11. mac-phisto says:

    now i hope none of you are suggesting that you deduct the interest paid on monies disbursed from a home equity loan to pay for cars as that would be tax fraud.

    the mortgage interest deduction is not designed to subsidize your auto purchases, you naughty tax evaders!

  12. kingoman says:

    Agreed that if you make the proper payments it can be beneficial to finance a car (or other short-term items) on a mortgage line of credit.

    However, the original article leaves out one major risk of doing so: If you get into trouble and default, they aren’t going to repo your car because it isn’t the collateral for your loan as it would be with a traditional car loan. Your HOUSE is the collateral for a LOC. Be careful.

  13. Also, one problem with the theory of “taking out a car loan and making more than the minimum payments.” With lots of car loans, they calculate the interest when you sign the loan, and you are required to pay all of that back. I took out a car loan when I graduated from college, and thought I would be thrifty and pay it back quicker. I found out it did not lower my payments down the road, and it made no difference. So I stopped doing it and paid it monthly. This may of changed, but I don’t think so. It was 20 years ago, and since then I buy used cars for cash.

    I have not used a Home Equity loan to buy a car, but it has piqued my interest.

  14. rbb says:

    @mac-phisto:
    The interest on home equity debt is quite deductible. From IRS Pub 936 (see #3):

    Fully deductible interest. In most cases, you will be able to deduct all of your home mortgage interest. Whether it is all deductible depends on the date you took out the mortgage, the amount of the mortgage, and your use of its proceeds.

    If all of your mortgages fit into one or more of the following three categories at all times during the year, you can deduct all of the interest on those mortgages. (If any one mortgage fits into more than one category, add the debt that fits in each category to your other debt in the same category.) If one or more of your mortgages does not fit into any of these categories, use Part II of this publication to figure the amount of interest you can deduct.

    The three categories are as follows.

    1. Mortgages you took out on or before October 13, 1987 (called grandfathered debt).

    2. Mortgages you took out after October 13, 1987, to buy, build, or improve your home (called home acquisition debt), but only if throughout 2006 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately).

    3. Mortgages you took out after October 13, 1987, other than to buy, build, or improve your home (called home equity debt), but only if throughout 2006 these mortgages totaled $100,000 or less ($50,000 or less if married filing separately) and totaled no more than the fair market value of your home reduced by (1) and (2).

    The dollar limits for the second and third categories apply to the combined mortgages on your main home and second home.

  15. Sudonum says:

    My wife and I did this a few years. She needed the tax deduction. We paid them off within 5 years, unfortunately our goal was to pay them off within 3.

  16. mac-phisto says:

    @rbb: it’s amazing how skipping over an “other than” in a gov’t publication can really change things.

    anyway, redact previous snark.

  17. rbb says:

    @mac-phisto:

    Besides – I considered my cars to be home improvement related. They sure make the house look a lot better in the driveway than my old beaters ;^)

  18. IRSistherootofallevil says:

    Using a home equity loan to buy a car is NOT tax evasion, it’s tax avoidance. The former will land you in prison, while the latter is perfectly legal. Besides, the government defrauds its taxpayers every single day, it’s only fair if the fraud is reciprocal.

  19. anatak says:

    The real problem with HELs or HELOCs or whatever other method they’ll come up with tomorrow, is that you are putting your home (where you sleep) in jeopardy for the ‘opportunity’ to borrow money. Whether or not you borrow for something stupid like a car, or a boat is irrelevant. Its the fact that you are usually living beyond your means and/or too impatient to save up the money to buy what you want/need – usually a want.

    “If you don’t have the discipline to pay more than the minimum payment on the home equity loan, it’s not a good idea to purchase a car this way.”

    Borrowing money to buy a car is a terrible idea anyways, but thats a different topic.

  20. pestie says:

    @JustAGuy2: My car loan’s interest rate is actually slightly lower than my home equity line of credit. If you’re a “disciplined person,” you’re probably already getting pretty good interest rates.

  21. JustAGuy2 says:

    @pestie:

    1. On an after-tax basis? (Unless you’re an AMT victim, in which case never mind)

    2. Did you get a subsidized rate? (i.e. 1.9% financing for 60 months with the purchase of a new Supermobile)

  22. pestie says:

    @JustAGuy2: I’ve never computed my after-tax rate, so I have no idea. The raw numbers are something like 8.xx percent for the car loan and 9.xx variable (prime plus 1.9%, I think) for the equity line of credit.

  23. JustAGuy2 says:

    Your mileage may vary, but I pay about 50% in marginal taxes, so that ~9% equity line of credit rate is about 4.5% after tax, 3.5% below your car loan. Figuring a $25k car loan, you may be paying $800/year or more in extra interest.

  24. bubuli says:

    i see that commenters here make a claim that interest on the home equity loan or HELOC to buy a car is tax-deductible…but if you do a quick search about this, nobody gives a straight answer…instead they point you to that IRS publication 936

    in any case, how much savings are we talking about here? ask yourself: is it worth to put your property at risk for that? in the event you can’t pay for a plain-vanilla car loan, your car gets repossesed, but if you’re using HELOC/HEL and you can’t pay…well, things get much more hairy, i would think…can you take THAT risk?