Should you use a home equity loan to pay off an auto loan?

On the one hand, you are struggling to find the ready cash to repay your car loan. On the other, your home has appreciated in value, and your equity (ownership) stake is worth a good amount. Could tapping that equity — that is, borrowing against it via a home equity loan or line of credit (HELOC) — be the answer to ending that auto debt?

It’s tempting, for sure. However, while home equity loans do typically come with more flexible terms and lower interest payments than auto loans, they can be risky to use to retire a car debt. Some risks include decreased home equity, high closing costs and potential foreclosure if you don’t pay off the loan. Longer repayment terms could also mean you end up paying off the loan past the life of your car.

Before using a home equity loan to make your car payments, here are all the considerations, and how to tell if this alternative would be better.

Home equity loans vs. auto loans: What’s the difference?

Both home equity loans and auto loans are types of secured debt: that is, the borrowed funds are backed by collateral, which can be seized if you default on payments. But they have significant differences, too.

A home equity loan is a second mortgage that lets you borrow against the equity you’ve built up in your home. When you take out a home equity loan, you’ll receive the funds in a lump sum and pay them back — at a fixed interest rate — over a set term of up to 30 years. You can use the money for various purposes, including home improvement and college expenses. However, if you can’t repay the funds, you could lose your home, which serves as collateral for the debt.

By comparison, an auto loan provides money for one purpose: to buy a car. Like home equity loans, auto loans have fixed interest rates; however, their loan terms are much shorter. In most cases, auto loans are secured by the car you purchase — so if you default, the lender can repossess your vehicle.

Should I use a home equity loan to pay off my auto loan?

Can you use a home equity loan to pay off your car? Well, sure. You can use a home equity loan for almost anything. But while it is possible to use a home equity loan to pay off your vehicle debt, it is generally not advisable to do so.

While a few one-year options exist, home equity loans are generally long-term debt, with terms that can extend for decades. A car’s market value begins depreciating the moment it leaves the lot, meaning

You must also consider that when you take out a home equity loan or HELOC, you are putting your home up as collateral. It could be in danger if you are unable to repay what you owe.

Benefits of using a home equity loan to pay off a car loan

• Flexible terms: Home equity loans generally have longer lifespans than auto loans. Home equity loan terms range from 5 to 30 years while car loan term lengths typically range from 2 to 7 years.
• Lower interest payments: Home equity loan interest rates tend to be less than auto loan interest rates, provided you have good credit.

Risks of using a home equity loan to pay off a car loan

• Loss of home equity: When you use your home equity to secure a loan, it decreases your equity stake — the portion of the home you own outright. If the amount you owe on that loan, your mortgage and any other home loans is more than your house is worth, you could become upside down on your mortgage. That could hamper your ability to sell your home.
• Closing costs: Some lenders charge upfront closing costs ranging from 2 percent to 5 percent of the loan amount. These charges combined with interest could have you paying more, despite lower interest rates.
• Longer repayment terms: Even though having a longer repayment term lowers your monthly payments, it also means that your loan could outlive your car. You could even end up paying off the loan for the old car while trying to finance a new one.
• Risk of foreclosure: If you are unable to make your monthly payments and get too behind on the debt, the lender can sell your home in order to recover the money you owe.

Considerations when paying off a car loan with a home equity loan

Before deciding to use a home equity loan to pay off car debt, make sure you’ve considered these factors.

Fixed vs. variable interest rates

Home equity loans and auto loans have fixed interest rates, but if you choose a home equity line of credit (HELOC), it will probably have a variable rate. Your HELOC interest rate can increase or decrease depending on the market. When your rate rises, you’ll end up paying more interest, making payments unexpectedly heavy.

Your home on the line

When you take out a home equity loan, your house serves as collateral – meaning that if you can’t pay back your loan, you could lose your home.

Fees

Home equity loans and HELOCs may come with certain fees, such as an origination or appraisal fee, as well as other closing costs (just like a mortgage). You might also face a prepayment penalty for repaying your loan or HELOC early.

How much can you save using a home equity loan on an auto loan?

Let’s say you’ve got five years and $15,000 remaining on your car loan, which has an interest rate of 7.91 percent (the current auto loan national average). Your payment on this loan is $304 per month, and your total interest paid is $3,210.

Currently, the average home equity loan interest rate is 8.60 percent. If you took out a five-year $15,000 loan at that rate, your monthly payment would be about $308, and you would pay $3,508 in total interest. That’s a bit pricier than an auto loan, based on the current rates for each product.

If you took out a home equity loan with longer repayment terms (for example, 15 years), you could reduce your monthly payment to $149. While this lower payment might sound appealing, there is a major downside: Over the life of the 15-year loan, you’d pay a hefty $11,746 in interest.

So, can you save by using a home equity loan to pay off car debt? Maybe, depending on the interest rates and repayment terms of the loans.

Auto loan interest rates depend on a few factors, with your creditworthiness playing a central role (higher credit scores equal lower rates). So, if you have excellent credit, it might make more financial sense to stick with an auto loan. But if your credit is average, the rates you get on auto and home equity loans will probably be more competitive.

What about HELOCs? Currently, average HELOC interest rates are sitting at 9.17 percent – higher than auto and home equity loans. However, one benefit of HELOCs is that you often don’t have to repay what you’ve borrowed for up to 10 years (you just make minimal interest payments). Plus, HELOC rates fluctuate, so there’s always a chance they could be lower when it’s time to start making principal repayments.

Alternative ways to pay your auto debt

Given all of the risks associated with using a home equity loan to pay off an auto loan, it is generally best to try other options before tapping into your home equity. Alternatives include:

• Refinance your auto loan: If you’ve had the car and the car loan for several years, you may qualify for lower interest rates, especially if your credit score has improved since you initially financed your vehicle. Refinancing does, however, come with fees that borrowers should be wary of.
• Renegotiate the auto loan: Lenders are often willing to renegotiate loans, particularly if you have good credit history and only need short-term assistance. Getting a payment deferred or stretching out the loan term could give you the time you need to get your payment together.
• Sell the vehicle: If you ultimately decide you can’t afford the car, you can sell it with the lender’s permission or trade it in with the dealership with which you’re financing. You will still be on the hook for the balance you owe, but it could relieve some of the future financial burden.

Bottom line on using home equity to pay auto loans

Cash-strapped homeowners falling behind on their car payments might look to home equity loans as a solution. The flexible terms and lower interest rates are appealing. However, using home equity as collateral is always risky. And if you’re even a little bit concerned about repayments, then adding to your overall home-related obligations — HE loan on top of a mortgage — isn’t a great option. Plus, the constantly depreciating value of the vehicle could make it not worth it to take out a 15- to 30-year loan.

However, a set of wheels is a necessity for many people, almost as vital as a roof over their heads. If you feel that taking out a home equity loan to pay off your vehicle debt is the right choice for you, research the best home equity loan rates and choose a lender you’d like to work with.