Buying car with home equity loan? Do the math

Buying car with home equity loan? Do the math (Louisville Courier-Journal)

WASHINGTON — Would you take out a 30-year car loan?

OK, you're probably thinking that sounds outrageous, so let me take it down a bit. How about a 10-year auto loan?

If you're financing a car purchase with the equity in your home, that is exactly what you could be doing -- paying for a car over 10 or even 30 years.

The use of home-equity loans, lines of credit and cash-out refinancing to purchase an automobile grew in the last decade as interest rates dropped and property values soared. It has become popular as lenders hyped the fact that interest on a home loan is tax-deductible.

In 2006, about 24 percent of homeowners used a home-equity line of credit to purchase a vehicle, according to Synergistics Research, a financial services consumer market research company in Atlanta. About 8 percent of homeowners took out a second mortgage to buy a vehicle, said William McCracken, Synergistics chief executive.

But is buying a car or paying off an auto loan with borrowed equity from your home wise?

"I issue a note of caution on this," said Don Taylor, a columnist for Bankrate.com and associate professor of finance at American College in Bryn Mawr, Pa. "If you don't have the discipline to do more than the minimum payments ... then this is not a good idea."

The assumption people make is that a home-equity loan is cheaper than a traditional car loan because of the mortgage interest tax break. But if you don't make extra payments or pay the loan off early, you end up paying more in interest over the life of that loan than you would with an auto loan.

I asked Taylor to run a few financing scenarios to compare the total cost of four types of auto borrowing -- a 60-month car loan, a 10-year home-equity loan, a 10-year home-equity line of credit and a 30-year cash-out mortgage refinance. To view the full results or to plug in your own loan figures, income-tax rate and interest rates, go to www.bankrate.com/compare.

Here's an example of an auto loan vs. a home-equity loan in which you finance $30,000. If you took out a five-year car loan at 7.76 percent (the national average), your monthly payment would be $604.85. Over 60 months, you would pay $6,291.11 in interest.

If you took out a 10-year home-equity loan for $30,000 at 7.88 percent, your monthly payments would be 362.08, Taylor calculated. Make extra payments of $242.77 during the first 60 months and you'd pay $6,417.71 in interest. If your federal marginal income-tax rate is 25 percent, your effective interest rate on the home-equity loan is 5.91 percent. Thus you would save $1,356.03 in interest.

But if you don't itemize your taxes to get the interest deduction and you don't pay extra every month, you end up paying $13,450 in interest, a difference of $7,158.89, according to Taylor's calculations.

The savings are even less with a home-equity line of credit vs. a home-equity loan because the interest rate is higher.

Considering a 30-year cash-out refinancing to buy a car or pay an auto loan? With rates at about 6.2 percent, your effective interest rate if you itemized would be 4.65 percent. But don't forget that with a refinance you have to factor in closing costs.

Whenever someone wants to know what I think about using their home's equity to purchase or pay off a car, I ask them this, "Have you done the math?"

While Michelle Singletary welcomes comments, she cannot offer personal financial advice. Write her at The Washington Post, 1150 15th St. NW, Washington, D.C. 20071.

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