Should I Use a HELOC to Buy a Car?

A Home Equity Line of Credit (HELOC) allows homeowners to borrow against the equity in their property. This financial tool provides a revolving line of credit, similar to a credit card, but it is secured by the borrower’s home. While HELOC funds can be used for almost any purpose, including a car purchase, it is important to understand the significant financial considerations before making such a decision.

Understanding Home Equity Lines of Credit

A HELOC uses the equity in a home as collateral. Equity is the portion of the home’s value the homeowner owns outright, calculated as the market value minus any outstanding mortgage balances. HELOCs function as revolving credit, allowing borrowers to access funds, repay, and re-borrow up to a set limit over a specified period.

HELOCs typically have two phases: a draw period and a repayment period. The draw period often lasts 5 to 10 years, during which borrowers may make interest-only payments. Once the draw period concludes, the loan transitions into a repayment period, commonly spanning 10 to 20 years, bringing the total HELOC lifespan to 20-30 years.

Most HELOCs have a variable interest rate, usually tied to a benchmark index like the U.S. Prime Rate, plus a lender-set margin. As the benchmark rate fluctuates, so can the HELOC interest rate, leading to changes in monthly payments. This variability means future payments are not fixed and can increase.

Using a HELOC for a Car Purchase

HELOCs offer flexibility in how funds are spent, as lenders generally do not restrict their use. Funds are available for various needs, including home improvements, education expenses, or a car purchase. Once approved, borrowers can access their credit line through methods like special checks, a dedicated debit card, or online transfers.

Drawing the desired amount allows for a cash purchase of the vehicle. The appeal of using a HELOC for a car often comes from potentially lower interest rates compared to other loan types, or the convenience of leveraging existing home equity without applying for a separate loan.

Critical Financial Implications

Using a HELOC for a car purchase has several financial implications. A HELOC is secured by the borrower’s home. If payments are not made, the homeowner risks foreclosure, a more severe consequence than vehicle repossession in a traditional auto loan default.

Cars are rapidly depreciating assets, meaning they lose a substantial portion of their value quickly. A new car can lose 16% to 20% of its value in the first year, and up to 60% within five years. HELOCs typically have long repayment periods, often 20 to 30 years. This means a borrower could owe significantly more on the HELOC than the car is worth for a prolonged period, known as being “upside down” on the loan.

The variable interest rate of most HELOCs presents additional risk. As the rate fluctuates based on a benchmark index, monthly payments can increase unpredictably. This volatility makes budgeting challenging and can lead to financial strain if rates rise significantly. While a HELOC might offer a lower initial interest rate than an auto loan, its extended repayment period often results in paying substantially more total interest.

Utilizing home equity for a depreciating asset also reduces available equity for other uses, such as home improvements that increase property value or funds for emergencies. A large HELOC can also affect a borrower’s debt-to-income (DTI) ratio, a measure lenders use to assess repayment capacity. A higher DTI ratio can impact the ability to qualify for other loans, like a mortgage refinance or another HELOC.

Alternative Car Financing Options

Several financing alternatives are generally more aligned with car purchases and financial planning goals. Traditional auto loans are a common choice, designed for vehicle financing. These loans are secured by the car itself and typically feature fixed interest rates. Auto loan terms are considerably shorter than HELOC terms, often 3 to 7 years, with the average new car loan term around 68 months. This shorter repayment schedule aligns more closely with a car’s depreciation curve.

Personal loans offer another financing avenue. These are typically unsecured loans, meaning they do not require collateral. While personal loans often have higher interest rates than secured auto loans or HELOCs, they provide fixed terms and predictable monthly payments, and they do not place a home at risk. The absence of collateral means the borrower’s other assets are not directly tied to the loan, reducing the severity of consequences in case of default.

The most financially advantageous option for purchasing a car is often a cash transaction. Paying with cash eliminates all interest payments, significantly reducing the overall cost. This approach avoids debt entirely, freeing up monthly cash flow and preserving home equity. While not always feasible, a cash purchase offers the greatest long-term financial benefit by avoiding borrowing costs.

Making an Informed Financial Decision

Deciding how to finance a car purchase requires evaluating personal financial circumstances and risk tolerance. While a HELOC offers access to funds and may have an appealing initial interest rate, its structure links the car loan to the borrower’s home equity, placing the home at risk. The long repayment periods and variable interest rates of HELOCs can lead to increased total interest paid and unpredictable monthly payments, which may not align with a vehicle’s rapid depreciation.

Individuals should assess their ability to manage payment increases and the long-term commitment of a HELOC for a depreciating asset. Considering the impact on future home equity and other borrowing capacities is also important.

It is beneficial to compare the total costs, risks, and repayment structures of a HELOC against traditional auto loans, personal loans, or a cash purchase. Consulting a financial advisor can provide tailored guidance based on financial situations and long-term objectives.