Planning to take out a home equity loan to buy a car? Check out our guide for things to consider and how to use home equity to buy a car.
Whether you’re headed to work or to school, a reliable form of transportation is essential for getting where you need to be. But while a car can make it easy to take control of your commute and your schedule, paying for one may feel inaccessible.
If you need a new ride but are shy on cash, you might want to use your home equity to buy a car.
But, can a home equity loan be used to purchase a new ride? Yes it can. Home equity loans make it possible to convert that equity into real money you can spend however you want (including on a new set of wheels).
Curious to know how to use home equity loan to buy a car? This guide provides a step-by-step course of action as well as home equity loan alternative options.
Understanding Home Equity Loans for a Car
Before you go full speed ahead and get a loan, it’s helpful to know what a home equity loan actually entails.
For starters, these loans function as a second mortgage, which may sound a bit daunting. Let’s break it down:
- A home equity loan provides homeowners a way to convert their home equity into cash. Home equity loans take the form of a lump-sum payment.
- A homeowner can borrow as much as 80% of their home’s market value if they own the home outright, or 80% of their equity’s value if there’s still a balance due on the mortgage.
- Your loan will come with a fixed rate, and you’ll need to start paying off the balance immediately.
Taking on a home equity loan for a car can be a risk since your home becomes collateral. For example, if you total the car and need to make costly repairs or buy a new vehicle, you’ll still owe money on your home equity loan. If you’re unable to keep up with monthly loan payments, you could face foreclosure proceedings.
In addition, keep in mind that cars tend to depreciate in value over time. As your vehicle depreciates, you’ll keep accumulating interest and making monthly loan payments on the borrowed funds. And finally, you’ll have sacrificed home equity that could otherwise be gaining value.
A home equity loan isn’t your only option. But if you’ve already weighed out the pros and cons of home equity loans and you’re ready to hit the gas, read on for the next step of your borrower’s journey.
Step 1: Evaluate the Costs
Your home’s value will influence how much you can borrow from the home equity to buy a car. A lender when considering you for a loan evaluates your home’s appraisal value. You can do the same to get a rough estimate of how much money you’re eligible to borrow.
- Your home equity is equal to the fair market value of the house minus any liens (including your mortgage loan).
- You can usually take out 80% of your equity in the form of a loan.
- For example, if your home is worth $200,000 and you owe $150,000 on your mortgage, you have $50,000 in equity. That means you might be eligible to take out up to $40,000—more than enough for a new set of wheels.
If the amount is more than what you need, perfect.
But again, think twice before taking out more than what’s required, since you’ll be adding that money directly to your overall debt. And while a home equity loan may carry a lower interest rate than an auto loan, you’ll be putting your house up as the bank’s guarantee of repayment.
Step 2: Make Sure You’re Qualified
Make sure you’ve evaluated your qualifications and understand what lenders want.
Lenders consider three important factors:
- Your home appraised market value
- Your income and debt history
- Your credit score
If you have a low credit score or hold less than 20% equity in your home, you may not qualify resulting in a denied home equity loan. In that case, you’ll need to seek out alternative options for a home equity loan with bad credit.
Calculate Your DTI Ratio
Wondering how debt impacts your loan eligibility? Lenders will take a thorough look at your debt-to-income ratio. This marker can influence how much you’ll be allowed to borrow.
Wondering how to calculate that on your own?
- Add up your total debts such as mortgage payment, student loans, car loans, any current loans, and credit card debt.
- Divide your debts from your income. The resulting percentage is your ratio.
You can also use an online financial calculator to get your DTI.
This is important information to know if you’re trying to determine your overall financial health and eligibility for future loans or products. Whether you are applying for a car loan or home equity loan, the lower your DTI, the better.
Step 3: Shop Rates
To guarantee that you’re getting the best deal, don’t be afraid to shop around.
It doesn’t make sense to take out a home equity loan unless it’s substantially lower than the auto loan rate you qualify for.
You’re not obligated to work with your current bank if you don’t want to. Have another lender in mind? Do some research to see what they’re about.
Things to consider as you shop different rates include:
- The loan term, which is usually 5 to 15 years but can be extended
- The offered interest rate
- The home equity closing costs and any fees
If you’ve found a rate that will help you save in the long term, fill out the paperwork and use the cash to buy your dream car.
But if you’re not quite ready to give lenders the keys to your home equity, investigate other options for financing your new vehicle.
Sale-Leaseback: An Alternate Way to Use Your Home Equity
If you get a standard automobile loan, your car is collateral. But if you get a home equity loan, your home is collateral. It may seem either way you have to take a loan and risk losing your home or your car.
Want a third solution? Consider a sale-leaseback program.
Sale-leaseback solutions don’t involve any home equity loan or personal loan. These personal and flexible programs never require using your home or car as collateral. That way, you can use your equity to buy a car without sacrificing your financial future.
How does this work? You sell your home and convert your home’s equity to cash. From there, you can lease your home back.
Whether you’re mulling over the financial plan for your retirement or considering options to consolidate your debt, you’ve probably come across reverse mortgages during your research. If you are still unsure of alternatives to reverse mortgages after reading this article, consult a financial advisor to discuss your options.
*This article is published for educational and informational purposes only. This content is based on research and/or other relevant articles and contains trusted sources, but does not express the concerns of EasyKnock. Our goal at EasyKnock is to provide readers with up-to-date and objective resources on real estate and mortgage-related topics. Our content is written by experienced contributors in the finance and real-estate space and all articles undergo an in-depth review process.
- Investopedia. Home Equity Loan. https://www.investopedia.com/terms/h/homeequityloan.asp