Home Equity Loan vs Car Loan: Best Way to Buy a Car

Borrowers looking for a way to finance a new or used car purchase have the option of a home equity loan. At first glance, home equity loans come with lower interest rates, quicker access to funds, and more manageable repayments than other financial products.

However, a home equity loan may not always be the best way to buy a car. In many cases, a car loan is still the best option to buy a new car - let’s dive into the differences between each.

What Is a Home Equity Loan?

A home equity loan allows borrowers to use the value of a home (equity) as collateral against the purchase of a car. Home equity refers to the total value of the property, minus any outstanding mortgage amount.

Borrowers can either apply with the existing home loan provider or with a separate home equity lender. When applying with an existing home loan provider, the borrowed amount is redrawn from the mortgage and is repaid under the same interest rate and loan term. Upon approval for the home equity loan, the lender provides the borrowed amount as a lump sum for the purchase of the car. 

Is a Home Equity Loan Better Than a Car Loan?

A home equity loan often comes with a lower interest rate than a typical car loan. The average interest rate for a home loan is between 5% and 6%, while the average interest rate for a car loan is 9%.

Although a home equity loan has a lower interest rate, the overall interest paid can end up amounting to more than a car loan. Home loans are paid over a long period (20-30 years) during which borrowers continue to pay interest. A car loan can be repaid much sooner, between 3 and 7 years. 

Key points to compare:

• Home equity loan repayments are lower than a car loan. This gives borrowers more financial flexibility throughout the repayment term.
• Car loans have a higher interest rate, but lower total interest paid over the loan. The shorter loan term offsets the higher interest rate.

When to Choose a Home Equity Loan

The best use of a home equity loan is to keep repayments low. Unlike a car loan, the borrowed amount can be spread out over a much longer loan term. However, as mentioned, this does mean that borrowers will end up paying a higher amount of interest over the life of the loan.  

This arrangement is ideal for borrowers who value financial flexibility over cost savings. Keeping manageable repayments also lowers the risk of defaulting on the loan. A home equity loan is secured against the value of the property, so failing to make repayments can mean losing ownership of the home.

Keep in mind that the terms of the home equity loan will be the same as the existing home loan. If your lender does not allow for additional borrowing or redraws, you may need to apply for a new loan with separate credit checks and conditions.

When to Choose a Car Loan 

A car loan is more suitable for borrowers who want a shorter loan, with less interest paid overall. 

Car loans can also offer flexible repayment terms, such as the ability to make extra repayments or a balloon payment. 

Whichever financing option you decide, it's important to review the different terms and rates offered by lenders on the market. A loan broker can work on your behalf to search and review loan options from multiple lenders at once to find one that perfectly meets your needs. Explore Before U Loan's extensive list of approved loan brokers across Australia to find the right loan option for a new car purchase.