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Use home equity loan to buy car
Bankrate.com
10/21/2005
Dear Dr. Don,
I own a condo and paid cash for it. Its value has tripled. If I need to finance a new car, should I apply for home equity loan or a home equity line of credit? Is the interest expense tax deductible on both types of loans?
Thank you for your help.
-- Nicole Nicety
Dear Nicole,
Congrats on the nice return on your condo investment. Tapping the condo's equity to finance a car purchase makes perfect sense -- if you're fairly disciplined with your finances.
A home equity loan is at a fixed interest rate, for a fixed loan term, with a self-amortizing loan payment; meaning that the monthly payment covers both the interest expense and the paying down of the principal balance. It's the classic choice for borrowing against your home's equity for a specific purpose, in your case financing a car.
In contrast, the home equity line of credit, or HELOC, is a variable-rate loan that typically has interest-only payments, at least in the early years of the loan. The interest rate is generally priced at a spread to the prime interest rate, which is currently 6.75 percent. You can track the prime interest rate on Bankrate using Rate Watch. The prime rate has been moving in lockstep with changes in the Federal Reserve Board's targeted Federal Funds rate, and the Fed isn't done with its current cycle of raising this short-term rate. As I write this reply, Bankrate's national average for a home equity loan is 7.21 percent and 6.84 percent for a HELOC.
The interest expense on a home equity loan or HELOC may be a tax-deductible expense but isn't always one. IRS Publication 936, Home Mortgage Interest Deduction, explains the limit on home equity debt. Talk to your tax professional if you're uncertain whether you can deduct the interest expense. Even if you aren't eligible for the deduction, the interest rate on the home equity loan is less than the current national average of 8.06 percent for a 48-month auto loan.
One advantage of the HELOC is that you can pay down the principal balance and then, at least in the early years of the loan, borrow that money again. Having an available balance on a home equity line of credit can substitute for emergency fund savings. If you don't have much flexibility in your finances, having an available balance on the HELOC can be important.
Since you don't have a first mortgage on the property, assuming you have a good credit score, you should be able to get a lender's best rate on a home equity loan or HELOC. Home equity financing is typically a second mortgage on the property and has a higher interest rate because of that standing. You don't have a first mortgage, so the home equity lender is first in line in foreclosure. That improved standing should translate into a lower rate on the loan. It won't be a lot, but you should see a difference between your rate and the advertised rate for the loan.
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