Some people purchase cars with funds from home equity products. Homeowners can extract equity from their homes in a variety of ways and generally lenders enable people to use funds for any legal purpose, including buying a car. There are some advantages to using home equity to finance a car but there are also disadvantages and people should carefully consider the pros and cons before making a decision.
Accessing Home Equity
There are three products that people can use to extract equity from their homes: a mortgage cash-out refinance, a home equity loan or a home equity line of credit. People who refinance can request to receive a cash disbursement at closing and use the funds when they please. Homeowners can take out home equity loans or lines of credit if they have available equity in their homes and these loans can occupy either first or second lien position.
Interest Rates
Mortgage rates are based on bond rates. Car loans usually have rates based on the U.S. prime rate. Bond rates and prime rate often move in opposite directions, meaning a cash out mortgage refinance might have a very low rate at a time when car loan rates are high. Home equity loans and car loans normally have fixed rates based on long-term projections for prime rate whereas home equity lines are variable and move in conjunction with prime.
Benefits of Using Home Equity
Generally, lenders view homes as better collateral than cars because automobiles have shorter lifespans and therefore car values depreciate while home prices may rise, stay steady or depreciate at a slower rate than cars. Loan rates are priced to mitigate risk so stronger collateral usually means lower interest rates. Therefore home loans usually cost less than car loans. Additionally, some people are able to write off interest payments for home loans whereas interest payments for cars are non-deductible.
Problems with Home Loans
People who finance cars with home equity lines could see their payments increase dramatically if the prime rate rises. Cash out refinances and home equity loans have fixed rates but closing costs are often very costly compared with auto loans, which have minimal processing fees. Even in instances where closing costs are low, people often end up paying more on a home loan because interest amortizes over 10 or 20 years whereas car loan terms are normally capped at six or seven years. Additionally, defaulting on a car loan leads to a car repossession but defaulting on a home loan leads to foreclosure.
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