What is a HELOC?
A HELOC is a secured loan that uses your home equity as collateral. The equity in your home is the difference between what you owe on your mortgage and the appraised value of your home. A HELOC is a revolving line of credit, similar to a credit card, that homeowners can draw on as needed. Your credit limit on a HELOC is determined by the lender.
You can access your line of credit in your HELOC during the draw period, which typically lasts for a set term. During the draw period, you can make interest-only payments on the money you borrow, depending on your loan terms.
After the draw period ends, you enter your repayment period during which you must pay off your outstanding balance in regular payments of the principal and interest on the loan. The repayment period is also a set number of years as determined by your lender. A HELOC generally has a variable interest rate rather than a fixed rate, so your payment amount can fluctuate over time.
You can use a HELOC to finance home improvement projects or renovations that your savings or income can’t cover. You can also use a HELOC to pay off larger existing debt, such as higher education loans, auto loans or for debt consolidation. Be aware that the interest on a HELOC may be tax deductible only if you use it to make improvements or renovations that add value to your home.
Pros and Cons of Using a HELOC To Pay Off a Car Loan
It’s crucial to weigh the pros and cons of using a home equity loan like a HELOC to pay off a car loan before deciding if this is the best option for you.
Alternatives to Using Home Equity
If you are looking to pay off your car loan, there are other options you can explore besides using a HELOC. In most cases, sticking with your existing car loan payments is the best way to go.
But it may be worth considering alternatives as they may present lower risks than using your home’s equity to get rid of your car debt.
- Personal loans: These loans are often unsecured, meaning you won’t need to provide collateral to secure your debt. They also have fixed interest rates to simplify planning for your monthly loan payment. You can also have access to your funds more quickly than with a HELOC. Personal loans, however, might have lower limits and may not cover your full debt amount. Also, you typically need a good credit score to qualify for a lower interest rate on a personal loan.
- Balance transfer cards: These credit cards offer a no-interest or low-interest balance transfer to pay off your car loan. This can allow you to make smaller monthly payments to pay off your debt. Not all credit card companies allow you to balance transfer a loan, so check with the card issuer. It’s important to be aware that once the limited-time promotional interest rate expires, the interest rate on the card may end up being higher than your original auto loan. You may also have to pay a balance transfer fee, which is usually a percentage of the balance transferred.
Key Factors to Consider
When you’re trying to determine if it makes financial sense to use a HELOC to pay off your car loan, it may be helpful to make a detailed comparison of your auto loan versus your potential HELOC loan terms. Pay careful attention to the following.
Interest Rates
Look at the differences in interest rates between the two loans — your auto loan has a fixed rate, while a HELOC will likely have a variable rate that can fluctuate and change your payment over the life of the loan. Determine if, even with changes in the variable rate, you will see any savings from interest.
Loan Terms
Compare loan terms and your payoff timeline. While your auto loan has payments toward the principal and interest that begin immediately, your potential HELOC typically will require interest-only payments during the draw period. Monthly payments on your HELOC of interest and principal begin after your line of credit closes and the repayment period begins.
Overall Costs
It’s essential to also compare the total costs of both loans to determine what makes more financial sense for you. Include any loan fees or charges to see what the total cost of each loan is. Calculate your break-even point — when your accumulated savings from the HELOC monthly payment exceeds the costs of the new loan.
Most importantly, make sure your income can support your loan payments and you can meet the payment timeline.
Setting Up Repayment
If you decide to use a HELOC loan to pay off your car loan, it may be wise to set up automatic monthly payments from your bank account. Automatically deducting at least the minimum payment from your checking account every month will help ensure you make your payments on time. This can help protect you from any late fees or damage to your credit resulting from late payments. You can always choose to make an additional or extra payment manually to your HELOC from your bank account.
When Does It Make Sense to Use a HELOC To Pay Off a Car Loan?
It may only make sense to use a HELOC to pay off your car loan in certain situations, such as when the equity in your home is substantial and you can easily borrow from it. It may also make sense when the HELOC’s interest rate is low enough that it provides significant savings compared to your car loan.
If the equity in your home is low, or if your income can barely cover the payments over the course of your HELOC loan, then it may prove too risky to follow this strategy. Consider speaking to a financial advisor for guidance to see if using a HELOC to pay off your car loan is right for your individual financial situation.
The Bottom Line
Using a HELOC to pay off a car loan can be wise in certain circumstances if significant savings can be gained from a lower interest rate or faster payoff with flexible repayment options. It’s crucial to be aware that using a HELOC to pay off debt like a car loan carries risks, including an impact on your home equity or foreclosing on your home if you’re unable to make your payments and default on your loan.
Review your overall finances and financial health before deciding on using a HELOC for your auto debt. It might be a good idea to determine how much equity you have in your home and if it makes sense to borrow from it. Make sure you can make the payments and meet the terms of your loan so that you don’t potentially impact your financial health.
If you decide to use a HELOC to pay off your car loan, it’s important to research multiple lenders to get the best offer and terms. Shop around to ensure you’re getting the best option that’s right for you.
Frequently Asked Questions About Using a HELOC to Pay Off a Car Loan
Using a personal loan or a HELOC to pay off your car depends on your own financial situation and what best meets your needs. A personal loan is not tied to collateral such as your home and has a fixed interest rate so that you can more easily plan for your monthly
payments. Personal loans, however, generally have lower limits and you will likely need at least good credit to qualify for a low interest rate. A HELOC may offer a lower interest rate and a higher limit, but it uses your home as collateral and typically has a variable interest rate that will cause your payments to fluctuate.
If you default on a HELOC used to pay off a car loan, you risk losing your house to foreclosure by your lender. Be certain that you’re prepared to manage your line of credit responsibly and that your budget supports paying back the principal and interest once you enter the repayment period. It’s crucial to ensure you can make the payment amount required in the timeframe determined by your loan terms.
If you have a HELOC and decide to use a portion of it to pay off your car loan, you can borrow as much as you need, up to the limit on your line of credit. Bear in mind, though, that the interest from any portion of a HELOC that is not used to significantly improve your home will not be tax deductible, according to the IRS.
Depending on your loan agreement, some lenders allow you to convert a portion or all of your HELOC balance to a fixed interest rate, although the fixed rate is typically higher than the variable rate. You will usually need to convert the rate before the end of your draw period.
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