Should I Pay Off My Car or Home Equity Loan?

Deciding how to manage personal debt can present a significant financial challenge, especially when faced with multiple obligations like a car loan and a home equity loan. Many individuals seek to reduce their overall debt burden and minimize interest costs. This article provides a framework to help you make an informed decision about which loan to prioritize paying off early, aligning with your unique financial situation and long-term objectives.

Understanding Your Loans

Car loans and home equity loans represent distinct types of debt, each with specific characteristics that influence a payoff strategy. A car loan is secured by the vehicle itself. These loans have fixed terms, commonly ranging from three to six years, and their interest is generally not tax-deductible.

In contrast, a home equity loan is secured by the equity in your home. These loans can be structured with a fixed interest rate, providing predictable monthly payments, or as a home equity line of credit (HELOC) with a variable rate. Interest paid on a home equity loan may be tax-deductible under specific conditions, which can effectively reduce its overall cost.

Key Financial Factors for Prioritization

When evaluating which loan to prioritize, several financial metrics deserve consideration. The interest rate on each loan is a primary factor, as paying off the debt with the highest rate first, often called the “debt avalanche” method, can lead to the greatest savings on interest over time. For instance, in the first quarter of 2025, the average auto loan interest rate for new cars was around 6.73%, while used cars averaged 11.87%. Conversely, the national average for home equity loan interest rates in August 2025 was approximately 8.23%, with HELOCs at about 8.12%.

The remaining loan term and outstanding principal balance also play a role. A larger principal on a loan, particularly one with a higher interest rate, will accumulate more interest over its remaining term. Evaluating these figures helps quantify the financial impact of accelerated payments.

Tax deductibility is another important distinction. Interest on home equity loans can be tax-deductible if funds are used to buy, build, or substantially improve the home that secures the loan. This IRS rule means interest used for home improvements may be classified as home acquisition debt.

The deduction is subject to limits, up to $750,000 of qualified mortgage debt (or $375,000 if married filing separately) for loans incurred after December 15, 2017, including both your primary mortgage and home equity loans. In contrast, interest paid on car loans is not tax-deductible. This tax benefit can lower the effective cost of a home equity loan.

While focusing on debt repayment, consider the opportunity cost of allocating funds to one loan over another. This involves evaluating other uses for the money, such as contributing to an investment portfolio or bolstering an emergency fund. The primary analysis should remain centered on comparing the direct financial benefits of paying down each debt.

Personal and Future Considerations

Beyond quantitative financial metrics, personal preferences and broader financial planning influence the debt payoff decision. An individual’s risk tolerance shapes their approach; some find peace of mind in eliminating debt, particularly on a rapidly depreciating asset like a car. Others might be more comfortable carrying debt, especially if it offers tax advantages.

Maintaining an emergency fund is important before aggressively paying down any debt. Avoid depleting savings to make extra loan payments if it leaves you financially vulnerable to unexpected expenses. A healthy emergency fund provides a safety net for unforeseen events, preventing the need to incur new, high-interest debt.

Considering future financial goals is another important aspect. If you anticipate selling your car soon, paying down that loan might offer immediate practical benefits, such as clear title. If you plan to refinance your home or save for other significant goals like retirement or a down payment on another property, your debt payoff strategy should align with these long-term goals.

The psychological impact of debt repayment should be considered. For some, eliminating a smaller, non-tax-deductible debt, such as a car loan, provides significant motivation. This approach, sometimes aligned with the “debt snowball” method, prioritizes the psychological win of clearing a debt, even if not always the most financially optimal choice based purely on interest rates.

Developing Your Debt Payoff Strategy

Creating an effective debt payoff strategy begins with assessing your current financial landscape. Gather all information for both your car loan and home equity loan, including current interest rates, outstanding principal balances, remaining loan terms, and any applicable tax implications. Understanding these details provides a clear picture of each debt’s characteristics.

Weigh the financial factors, such as interest rates and tax deductibility, against your personal preferences and future goals. There is no universally correct answer, as the optimal strategy depends on your individual circumstances and priorities. For instance, if your car loan has a significantly higher interest rate and no tax benefit, prioritizing it might be financially advantageous.

Once you determine your preferred strategy, implement steps to achieve your goal. This might involve consistently making extra principal payments on the chosen loan, adjusting your monthly budget to free up additional funds for debt reduction, or exploring options to refinance one of the loans to a lower interest rate. For personalized guidance, consulting with a qualified financial advisor can provide tailored advice. Regularly reviewing your strategy and making adjustments ensures your plan remains effective.