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How do car loans work?
The logistics of buying a car can be a daunting task, but paying for it doesn’t have to be. If you’re a homeowner, you might be asking, can I use a HELOC to buy a car? The short answer is yes. And while there are many ways to finance a car, here we cover the basics when choosing between a car loan and a home equity line of credit (HELOC) to finance your next automobile purchase.
A car loan allows you to borrow money from a dealer or financial institution to buy a car. You agree to pay it back monthly over a set period of time plus any fees and interest you accrue. Your monthly payment depends on the amount of the loan, the term of the loan, and the interest rate. Consider shopping around with different lenders to determine which loan works best.
Getting your car loan approved
Typically, you have to complete a loan application with information about your financial situation to receive a car loan. The approval process usually begins with a prequalification that does a soft check on your credit, which shouldn’t affect your credit score. Once you’re pre-approved and decide to proceed with the loan, the lender typically pulls a hard inquiry on your credit, which can cause a dip in your credit score for a short period of time.
What is a home equity line of credit?
A home equity line of credit (HELOC) is a funding source that allows borrowers to access the equity in their home. Since HELOCs are secured by your home equity, they often carry competitive interest rates compared to other funding sources.
If you’re a homeowner, you know that as the mortgage amount on a home loan decreases, the equity of the home increases, which ultimately increases the HELOC.
Qualifying for a HELOC Loan
While a car loan is based on the amount you need for a specific automobile purchase, a HELOC is based on your home equity and can be used for essentially anything.
When you apply for a HELOC, the lender runs your credit, looks at your financial health, and does due diligence regarding your home’s value before offering the amount you’re eligible for. Get a quick estimate of how much you may be eligible to receive from a HELOC by using Prosper’s HELOC calculator.
The pros and cons of buying a car with a home equity line of credit
Let’s consider the pros and cons of using a home equity line of credit to purchase a car:
● Lower interest rate
Some homeowners use a HELOC to buy a car because the interest rate can be lower than the interest rate on a traditional auto loan. If you have good credit, you may qualify for a low rate regardless of how you choose to finance the car. However, you may discover that a HELOC offers the lowest interest rate and the lowest monthly payment.
● Increased negotiating power
A HELOC may offer a larger credit limit than an auto loan, allowing you more bargaining power when negotiating the price of the car. If you pay the full price up front, you may also be eligible for a rebate.
● Tax benefits
The interest you pay on a HELOC may be tax deductible if you choose to itemize deductions. There are zero tax perks when you use a car loan. It is recommended, however, that you consult your accountant or tax preparation service as this is subject to change based on current tax laws or your locality.
● Closing costs
Some HELOCs have closing costs, which can range from 2%-5% of the total line of credit. These costs can be paid out of pocket at closing, either by financing them with proceeds of the HELOC, or by paying them in cash. You may be able to negotiate a no closing costs option.[AP2]
● Risk of foreclosure
You could be at risk of losing your home. In this scenario, your home acts as collateral for the HELOC. If you’re unable to make the payments, the lender has the option to sell your home to recoup the debt that you owe.
● Less interest, long repayment term
The longer repayment timeline of a HELOC could lower your monthly payments, but the loan could outlive your car. On average, consumers own their cars for 8.4 years, while the average HELOC has a repayment term of up to twenty years. This could result in you still repaying the HELOC for the old car while financing a new one.
Should I use a HELOC to buy a car?
Using a HELOC to purchase a car is a common practice, and you may get a better interest rate on your loan. However, before you make a decision, consider the risks of using your home as collateral and the drawbacks of choosing a longer loan. As a general rule, it’s not a good idea to carry debt any longer than you have to—especially for a car that will quickly depreciate—though it may work best for you depending on your financial situation.