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Home Equity Loans vs. Auto Loans: Which to Choose?

last updated October 31, 2013 by

Home ownership comes with its perks, including the ability to draw on equity in the home for a home equity loan.  For home owners who have paid a significant portion of the principal off on their mortgage, a home equity loan might seem like an attractive alternative to financing an auto purchase through the dealer or another lender.  However, home equity loans are not viable for everyone, and they can cause a great deal of misfortune for home owners that fall behind on car payments.

Differences between Auto Loans and Home Equity Loans

Both auto loans and home equity loans are secured loans, meaning they use a piece of property as collateral for the loan.  In an auto loan, the title of the car is held by the lender, and they can repossess the car if the borrower stops making payments.  In a home equity loan, normally used for home improvements, the house itself is the collateral and could potentially be foreclosed upon if the home equity loan is in arrears.

Dangers of Home Equity Loans

Home equity loans, because they are secured by collateral of great value, typically have lower interest rates than comparable auto loans.  On the other hand, people who borrow against their homes are putting themselves at risk of foreclosure if they are unable to make payments in the future.  While home equity loans are ideal for people with steady employment and a low mortgage, they are a poor choice for people with bad credit that are in between jobs or searching for a new job.

Benefits of Home Equity Loans

Home equity loans have some benefits over auto loans.  Over the life of a $20,000 loan, the typical home equity loan will save borrowers around 12.5% over the auto loan, as a direct result of lower interest payments.  Additionally, while interest payments on auto loans are not tax-deductible, interest payments on home equity loans usually are.  Home equity loans can also be made through a home equity line of credit, a revolving credit balance that borrows against the value of a home.

Which to Choose?  Home Equity or Auto Financing

For the majority of borrowers, traditional auto financing is the safest financial choice.  There are dozens of auto loan companies that offer rates comparable to those secured in home equity loans, but at a much lower risk to the borrower.  If the worst was to happen, and you were to default on your loan, it is much less disruptive to your life to lose a car than to lose your home.