Should You Buy a Car With a Home Equity Loan or a Car Loan?

Home equity loan vs. car loan: Which should you use to buy your next vehicle? An auto loan is typically the better bet for most borrowers because it’s designed specifically for car purchases and doesn’t put your home at risk. 

On the other hand, a home equity loan might have lower monthly payments and the flexibility to use any leftover loan funds for other purposes. Let’s compare these two financing options to help you make an informed decision. 

Home equity loan vs. car loan: What’s the best way to buy a vehicle?

In most cases, a car loan is better for buying a vehicle because it’s cheaper in the long-run and less risky. But if you have a lot of value built up in your home, a home equity loan could work. 

This table gives a quick comparison of home equity loans vs. auto loans. We’ll dive into each of these factors more in-depth below: 

Factor	Home equity loan	Car loan
Collateral	Your house	The car
Interest rates	Fixed	Fixed
Loan terms	5 – 30 years	2 – 8 years
Closing costs	Yes	Minimal to none
Risk level	Higher	Lower

Collateral and risk

Both auto loans and home equity loans are secured debts. This means they both have a piece of collateral backing them up that your lender can take if you default on payments. 

Home equity loans are secured by the house itself. If you default on this second mortgage, your house could go into foreclosure. 

Car loans are secured by the vehicle itself. If you can’t pay your loan, you might lose the car, but you won’t lose your house. This makes auto loans inherently less risky. 

Also, cars are depreciating assets. It’s generally not advised to put your home on the line for something that’s bound to lose value every year. This is another reason why many experts say you shouldn’t use a home equity loan to buy a car.

Interest rates

Auto and home equity loans have fixed interest rates, meaning you keep the same APR for your entire loan term. But which option has better rates can vary. 

Right now, car loans generally have lower interest rates than home equity loans. For example, you might find a car loan with rates starting at around 5%, while a home equity loan might start at 7%. 

The relative competitiveness of these rates can shift based on market conditions. Sometimes auto loans offer better rates. But other times, home equity loans are more favorable. Which loan has the better rates will also depend on your creditworthiness.

Loan terms

It’s normal to pay home equity loans back over a five to 30-year period. Car loans are usually much shorter, lasting about two to eight years. 

Because home equity loans have longer terms, you’ll have a smaller car payment if you go this route. But the trade-off is that you’ll pay more interest over time because it’ll take longer to pay back.

Closing costs

Home equity loans can sometimes have closing costs, much like your mortgage. These costs can consist of application fees, origination fees, and appraisal fees. 

Car loans usually don’t have these extra costs, but you may be asked to make a down payment for the vehicle you wish to buy. 

This down payment will lower the amount you need to borrow, which in return will lower your monthly payment. However, closing costs would not lower your loan amount. This is something else to keep in mind. 

Pros and cons of auto loans

Pros

• Lower risk

  You only risk repossession of your car—not your home—if you can’t make payments.

• Competitive interest rates

  Auto loan rates can be lower than home equity loan rates, depending on market conditions and your credit score.

• Shorter repayment terms

  You’ll typically pay your loan back in fixed monthly installments over a two to eight-year period. This shorter time frame helps you avoid long-term debt on a depreciating asset. 

• Minimal upfront costs

  Unlike home equity loans, auto loans typically don’t have closing costs.

• More lender options

  You can shop around between dealerships, banks, credit unions, and online lenders for the best deal.

• Easier to refinance

  If your credit improves or rates drop, you can often refinance for an installment loan with better terms without needing to renegotiate your home’s equity.

Cons

• Higher monthly payments

  Shorter loan terms mean higher monthly payments compared to home equity loans.

• Credit-dependent terms

  Your credit score will impact your interest rate and approval odds. You might need a cosigner if your credit is poor.

• Potential for negative equity

  Cars depreciate quickly, so you might owe more than you’d get if you sell the vehicle during part of the loan term.

• Limited use of funds

  You can only use the loan for car purchases, unlike a home equity loan you can use for almost any purpose.

• Pressure at dealerships

  You might face high-pressure sales tactics to accept dealer financing, which isn’t always the best deal.

Pros and cons of home equity loans for car purchases

Pros

• Potentially lower interest rates

  Depending on market conditions and your financial situation, you might qualify for a home equity loan with a lower rate than an auto loan.

• Longer repayment terms

  These loans have flexible terms that can stretch from five to 30 years and result in lower fixed monthly payments.

• More ways to use the funds

  Unlike auto loans, you can use a home equity line of credit (HELOC) or loan for more than just a vehicle purchase. You can put leftover funds toward other goals.

• No restrictions on vehicle type

  You can finance any car, regardless of age or mileage. Some auto loans have vehicle restrictions.

• Higher borrowing limits

  You might be able to borrow more than with a traditional auto loan based on your home’s equity.

Cons

• Risk to your home

  Your house is collateral, so defaulting could lead to potential foreclosure.

• Decreased home equity

  You’re reducing your ownership stake in your home to buy a depreciating asset, potentially putting you upside down on your mortgage.

• Higher fees

  Expect to pay closing costs and other fees that you wouldn’t have with an auto loan.

• Longer processing times

  Most home equity loans take two weeks to two months to close. An auto loan is generally much faster.

• Longer debt period

  Longer repayment terms mean you could still be paying for the car long after it’s gone. Plus, you’ll likely pay way more in interest, even with a lower interest rate.

• Complicates home transactions

  If you ever decide to sell or refinance your home, having this additional lien on your property will complicate things. 

• Temptation to overspend

  Access to more funds might tempt you to buy a more expensive car than necessary.

When should I use home equity for a car purchase?

Just because you can use home equity to buy a car doesn’t mean you should. A traditional auto loan is usually a safer and more financially sound choice for most people. But in some cases, using home equity might offer a better deal. 

For instance, you might consider using home equity if: 

• You want to buy a car that doesn’t easily qualify for an auto loan.
• You already have leftover funds from a home equity line.
• You qualify for much lower-interest financing than with an auto loan.
• You’re in an emergency situation and need a new vehicle with the lowest monthly payment possible, even if it means paying more in interest in the long term.

The easiest way to know which financing option is best is to get quotes for auto and home equity loans. Add up all interest and fees to compare overall costs.

For example, say you need $40,000 to purchase a new Toyota 4Runner. You’re weighing these options:

	Auto loan	Home equity loan
Rate (APR)	4.5%	7.35%
Loan term	5 years	10 years
Monthly payment	$746	$472
Total interest paid	$4,743	$16,602
Total cost	$44,743	$56,602

As you can see, the home equity loan has lower monthly payments but increases the total cost of this depreciating asset by almost $12,000. 

If you go this route, you’ll need to think about how this extra car debt might impact your net worth and if risking your house (which will serve as collateral) is worth it. 

I personally have not recommended a home equity loan to a client for the purchase of an automobile because it is a depreciating asset. However, it could make sense if you are in sound financial condition, can obtain a more favorable interest rate than a car loan, and can pay off the loan in the short term (I recommend no longer than five years).

Erin Kinkade, CFP®

What are the best auto loans?

If you decide to finance your vehicle purchase with an auto loan, the next step is finding the best lender. To make your search easier, we’ve compiled a list of the best auto loan lenders below.

What are the best home equity loans for a car purchase?

If you’ve carefully considered the risks of using a home equity loan to buy a car and still want to move forward, the next step is finding the best possible terms. Our team has spent over 100 hours collectively researching the best home equity loans and has compiled this list of top-rated lenders to help you sort through your options.

FAQ

What are alternatives if I don’t want to take out an auto loan or a home equity loan for a car purchase?

If you prefer not to use an auto loan or a home equity loan, you have several other options. You could consider a personal loan, which may offer more flexibility but could come with higher interest rates. 

Leasing a car is another alternative. This allows you to drive a new vehicle with lower upfront costs, though you won’t own it outright. If you have a high enough limit, you could use a credit card for the purchase, but be mindful of the typically higher interest rates associated with this option.

How do I apply for a home equity loan?

To apply for a home equity loan, start by checking your home’s current equity. Lenders typically require at least 15% equity. Next, shop around for lenders, comparing interest rates and loan terms. 

Once you’ve selected a lender, submit an application with documentation, such as proof of income, homeownership, and property value. After approval, most lenders will conduct an appraisal before finalizing the loan.

How do I apply for an auto loan?

Applying for an auto loan usually begins with checking your credit score and determining your budget. Next, research lenders, including banks, credit unions, and online lenders, to compare rates and terms. 

You’ll then apply, providing information about your employment, income, and the vehicle you wish to purchase. If approved, the lender will provide the loan amount, and you’ll finalize the purchase with the dealer or private seller.