Should I Use Home Equity to Pay Off Car Loan?

Homeowners often face the decision of how to best manage their debts, and a common question arises when considering a car loan alongside available home equity. This financial choice involves weighing the nature of different debt types and their long-term implications. Understanding the distinct characteristics of each loan and the potential outcomes of using one to address the other is important for informed financial planning.

Understanding Home Equity Access

Home equity represents the portion of your home’s value that you own outright, calculated as the current market value of your property minus any outstanding mortgage balances. Homeowners can access this equity for borrowing purposes primarily through two financial products: a Home Equity Line of Credit (HELOC) or a cash-out refinance. These are both loans secured by the borrower’s primary residence, meaning the home itself serves as collateral.

A Home Equity Line of Credit (HELOC) functions as a revolving credit line, similar to a credit card, allowing you to borrow funds as needed up to an approved limit. These lines of credit feature variable interest rates, averaging around 8.12% in August 2025. A HELOC has two phases: a draw period (commonly 10 years) for accessing funds and making interest-only payments, followed by a repayment period (typically 10 to 20 years) requiring principal and interest payments. Closing costs for a HELOC typically range from 2% to 5% of the credit limit.

Alternatively, a cash-out refinance involves replacing your existing mortgage with a new, larger mortgage. The difference between your old loan balance and the new, higher loan amount is received as a lump sum of cash. This new mortgage is secured by your home and comes with a fixed interest rate, with the national average 30-year fixed refinance APR at approximately 6.83% in August 2025. Cash-out refinances typically incur closing costs ranging from 2% to 6% of the new loan amount.

Home equity loans offer a third option, providing a lump sum of money at a fixed interest rate, averaging around 8.23% in August 2025. These loans are repaid over a fixed term, commonly ranging from 5 to 30 years. Home equity loans are secured by your residence and involve closing costs, generally between 2% and 6% of the total loan amount.

Understanding Car Loan Characteristics

Car loans are a common form of secured debt, meaning the vehicle purchased serves as collateral for the loan. If loan payments are not made as agreed, the lender has the right to repossess the car. Interest rates on car loans are higher than those on mortgage-backed loans due to the depreciating nature of the collateral.

In the first quarter of 2025, average interest rates for new car loans were approximately 6.73%, while used car loans carried a higher average of about 11.87%. These rates can vary significantly based on creditworthiness. Car loan terms are much shorter than mortgage terms, typically ranging from 24 to 84 months. The average car loan term was around 68 months for new cars and 67 months for used cars in early 2025. Vehicles experience significant depreciation over time.

Analyzing the Financial Implications of Consolidation

Consolidating a car loan into home equity debt involves a fundamental change in the type of collateral securing the debt. The debt shifts from being secured by a depreciating asset (the car) to an appreciating asset (your home). This introduces the risk that failure to make payments could lead to the loss of your home, a more severe consequence than vehicle repossession.

Home equity interest rates are generally lower than car loan rates, with HELOCs averaging 8.12% and cash-out refinances 6.83% in August 2025, compared to car loan rates from 6.73% (new) to 11.87% (used). While a lower interest rate can reduce monthly payments, it is important to consider whether the home equity product has a fixed or variable rate, as variable rates can fluctuate.

Consolidating a car loan, which typically has a 2 to 7 year term, into a home equity loan or refinance can extend the repayment period significantly, often to 15, 20, or 30 years. This extension, despite a lower interest rate, often results in paying more total interest over the loan’s life. For example, a car loan paid off in five years could now be amortized over decades, leading to a higher cumulative interest cost.

Interest paid on home equity loans or HELOCs is generally only tax-deductible if funds are used to buy, build, or substantially improve the home that secures the loan. If funds are used for other purposes, such as consolidating a car loan, the interest is typically not deductible. There are limits on the amount of qualified residence debt for which interest is deductible, currently up to $750,000 for married couples filing jointly.

Applying for a home equity loan or refinance can have a short-term impact on your credit score due to the credit inquiry. Successful management of the consolidated debt and consistent on-time payments can positively affect your credit score over the long term. Missing payments on a home equity loan can severely damage your credit and risk foreclosure.

Obtaining a home equity loan or cash-out refinance involves closing costs, which typically range from 2% to 6% of the loan amount. These upfront fees can add thousands of dollars to the transaction cost, potentially offsetting some interest savings from a lower rate. Factor these costs into the overall financial assessment.

Using home equity to pay off a car loan reduces the available equity in your home. This depletion could limit access to funds for future needs, such as home repairs or medical emergencies. It means a smaller portion of your home’s value would be available if you were to sell the property.

Exploring Alternative Debt Strategies

Other strategies exist for managing car loan debt before using home equity. One option is refinancing the car loan with another lender. This might secure a lower interest rate or a more favorable term, reducing monthly payments or total interest paid without putting your home at risk.

Making extra payments on the car loan whenever possible can accelerate its payoff, reducing the total interest accrued. Even small additional amounts can make a difference. Creating a budget and identifying areas to cut expenses can free up cash for this purpose.

Another consideration is selling the current vehicle and purchasing a less expensive one. This action can eliminate the existing car loan debt or reduce the amount owed, aligning transportation costs with financial capacity. These approaches focus directly on the car loan without involving your home.