Pros and Cons of Using Home Equity to Buy A Car

A new car is a big ticket item - for many, this means applying for external finance to fund the purchase. Standard finance options like a car loan or personal loan are common - but as a homeowner, you have the added option of tapping into the equity in your property to fund a used or new car.

Like any financial option, using the equity in your home comes with pros and cons (depending on your situation) that will impact its suitability for car finance.

How Home Equity Is Used for Car Finance 

Home equity is the value of the property you own, calculated as the difference between the property’s market value and the outstanding balance on the mortgage. Homeowners can use this equity as security for a loan, giving lenders more confidence, and in return they offer lower interest rates and more flexible loan terms for the borrowed funds.

Borrowers can apply for a home equity loan in three ways: 

• Redraw funds on an existing home loan - withdrawing funds from extra repayments that have already been made.
• Top up on an existing home loan - borrowing additional funds on the current mortgage.
• Refinancing a new home loan with the current lender or a new lender to increase the borrowed amount. 

Lenders usually allow borrowers to access up to 80% of their home equity without charging Lenders Mortgage Insurance (LMI). LMI is a separate fee that is charged to borrowers to protect the lender against the risk of borrowers defaulting on the loan.

If the loan is approved, the funds will be dispersed to purchase the car - just like a regular car loan.

Pros of Buying A Car with Home Equity

Lower interest rates 

A home equity loan can come with lower interest rates than a typical car loan. In general, the higher the equity used to secure the loan, the more favourable the interest rates offered by lenders.

Lower interest rates are one thing, but it’s important to calculate and compare the total interest over the loan term for a home equity loan vs a car loan.

Smaller monthly repayments

A home equity loan will have longer loan terms than a traditional car loan and lower interest rates, which means lower monthly repayment commitments. Ideal for managing cashflow and reducing monthly debts, smaller monthly repayments can reduce the risk of defaulting on the loan.

Consolidated loan 

Using a home equity loan to purchase a car simplifies repayments. You’re combining an existing mortgage with your car loan which means one consolidated monthly payment.

Cons of Using Home Equity to Buy a Car

Significantly longer loan term

A home equity loan will have a longer repayment term in the contract. Car loans are usually paid off over 5 to 10 years, where a home equity loan comes under your mortgage which is paid off over 20 to 30 years.

For some, this is a benefit as it does result in lower monthly repayments. However, for others, such a long commitment can be daunting.

More interest paid over the loan

Despite a lower interest rate, home equity to finance a car purchase can still mean paying more interest in total, over the course of the loan. Here’s a breakdown of potential interest paid in a car loan vs home equity loan for $50,000.

Risks of defaulting

When you consolidate your home loan and car loan under a home equity loan, the worst case scenario of defaulting can come with a large risk - losing you home. The risk is also increased if you are in negative equity, which is when the outstanding amount on the mortgage is higher than the current property value. 

A home equity loan can be a great solution for those who can commit to the long terms and consolidated monthly repayments. However, it’s not suited to everyone in the market for a car loan. It’s important to speak to a loan broker who can assess your financial situation and provide tailored advice - get in touch with our approved list of brokers to obtain the right advice for your circumstances.