Is a Car or Home Equity Loan the better Choice?
This calculator can be used to estimate the advantage a home equity loan may provide compared to a traditional car loan. The calculator needs a total of nine inputs, including:
- The negotiated price of the automobile
- Any upfront money paid or trade-in allowance provided by the dealer towards the new car
- The rate of interest charged on the new car loan
- Origination and other fees associated with the car loan
- The term of the car loan, stated in months
- The rate of interest charged on the home equity loan
- Origination and other fees associated with the home equity loan
- The term of the home equity loan, stated in months
- The household’s incremental federal income tax bracket (see note below)
The calculator then provides the user with eleven outputs:
- The net financing, which is how much money is borrowed and is found by subtracting the down payment from the negotiated price of the car
- The monthly payment for the car loan, home equity loan, and any savings associated with the home equity loan (displayed as a positive number)
- The total of all payments made for the automobile loan
- The total of all interest and fees associated with the automobile loan
- The total of all payments made for the home equity loan
- The total of all interest and fees associated with the home equity loan
- The tax benefit provided by the home equity loan (see note on this later)
- The net cost of the home equity loan
- Finally, the savings provided by the home equity loan relative to a car loan
Note: Home equity loans may NOT be tax deductible in certain jurisdictions. For example, a home equity loan used to pay for a new car is not federally tax deductible in the United States.
Borrowing Decision: Home Equity versus a Car Loan
Homeowners oftentimes have the choice to take out a car loan or use the equity in their homes to make their purchase. Both loans involve collateral, which is an asset that can be sold by the lender to repay the loan if the borrower defaults. The big advantage of a home equity loan is they usually carry a lower rate of interest, so the monthly payments will be lower. The size of a home equity loan is dictated by the amount of equity the borrower has in their home. For example, if the market value of the home is 400,000 and the outstanding loans (including a mortgage) on the home was 100,000, then the borrower would have 300,000 in equity in their home and might be able to borrow up to 50% of that equity. In this case, that’s up to 150,000.
The terms on a home equity loan are usually longer than a car loan, which lowers the monthly payment. For some borrowers, the combination of lower interest rates and longer terms is attractive. Paying off a loan over a longer period of time does mean higher interest charges. That’s where our calculator can help. By comparing the net cost of the home equity loan to the interest plus fees of the car loan, we can better understand the total cost of each option. If the Savings value is negative, that tells us the home equity loan is more expensive than a car loan – even if the monthly payments are lower.
Home Equity Loans and Income Tax Deductibility
In the United States, a home equity loan is tax deductible if the money is used to make an improvement to the home. Borrowing money to pay for a new car is not tax deductible in the United States. If such a loan is taken out after December 16, 2017, there is also a limit on the size of the loan, which is 750,000 (total of all loans). If you live in a jurisdiction where home equity loans are deductible from an income tax, then enter your incremental tax rate into the calculator. If not, then make the value zero.