People have been known to look at the equity in their home as a low cost source of credit for any use. After all, opening a home equity line of credit, HELOC for short, comes with a lower interest rate than many other types of credit and the payments can be extended far longer than with many installment loans. One prime example is using a HELOC to buy a car that you may not be able to finance otherwise. Yes, you can do this, but the question is this: does it make sense to do so just because you can?
Below, we’ve included a detailed of reasons why you should–and more importantly, shouldn’t–use a HELOC to finance the purchase of your next vehicle.
Reasons Why You Should
- Topping the list is the chance to have a lower monthly payment. That may allow you to buy more car than you could afford otherwise. Car loans have a traditional repayment period of between 36 and 72 months, but a HELOC is spread over ten to fifteen years. Plus, you do have the option of paying a HELOC off early.
- What if you fall on hard times financially? For instance, you lose your job, endure a natural disaster, or face unexpected medical or veterinary bills. With a traditional car loan you will have two options: struggle with the payments and neglect other things or default. With a HELOC you have the ability to make interest only payments for a short time, perhaps avoiding a default on any of your accounts.
- The final pro to using a HELOC to buy a car that I can think of is the chance of a tax deduction. Under certain circumstances, and only if you itemize, the interest on a HELOC can be used as a tax deduction. You will need to consult a tax professional before attempting to take this type of deduction.
Reasons Why You Shouldn’t
- Traditional car loans have a fixed rate and are simple interest accounts. A HELOC, on the other hand, is a variable rate, compounding interest loan. That means that your interest rate can change on a monthly basis. Fifteen years of changing interest rates would drive many people to the brink of madness.
- Unless you have a concrete plan to repay the HELOC in a short period of time, the loan may outlast the vehicle you purchase. The only way to avoid that would be to double your monthly payments, eliminating the lower payment benefit of a HELOC. Imagine having a payment on a HELOC and another one on a car loan to replace the vehicle you originally took out the HELOC to buy. What a nightmare that would be.
- One last thought. Actually, two thoughts along the same line. What if you decide to sell your home? Remember a HELOC decreases the amount of equity in your home by the account balance. First, that HELOC might decrease the equity to the point that you will not have enough left over to put a down payment on another home. Second, what if market values in your area have gone down? That means that the combination of your mortgage and the HELOC may have you underwater on your home and unable to sell.
HELOC as a Car Loan: Probably a Bad Idea
Overall, using a HELOC to purchase any depreciating asset is probably a bad idea. The extended repayment period is greatly overshadowed by the compounding interest that will accumulate over the life of the loan. Commit to making higher payments to reduce the interest paid and you have erased the lower payment benefit of a HELOC. The only reasons to use a HELOC would be necessary major repairs to your home such a a new roof or renovations that add value to your home.
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