August 01, 2017
If you’re in the market for a new car it can be tempting to dip into your home equity to fund the purchase. But there are good reasons to consider a car loan. We look at what to weigh up.
If you’ve been in your home for a while, chances are you’ve built up home equity, and this can be used to provide low-interest funds for a new car.
On the plus side, there’s no need for additional credit checks, and you’ll still make only one repayment each month.
However, the key benefit of using home equity is that home loan interest rates are typically far lower than those you can expect to pay on a car loan. But there’s a catch.
Home loans are a very long term debt. So you’ll be paying interest on the car for a far longer period than you would with a car loan, and that can really ramp up the cost of the vehicle.
As a guide, adding an extra $30,000 onto a $400,000 home loan can mean paying as much as $19,527 more in overall interest1. That’s more than half the cost of the car.
Making extra repayments is one way to combat this problem but it calls for an ongoing commitment to pay more than the monthly minimum repayment. Remember too, unlike our homes, cars rapidly depreciate in value so it makes good financial sense to keep interest costs to a minimum by paying off the vehicle as soon as possible.
The upsides of using a car loan
Using a separate car loan may mean paying more each month, and that’s largely because the debt is being paid off over a faster timeframe. However, the big advantage is that car loans have short terms, usually five years, so even though the loan rate may be higher than for your home loan, the total interest cost will be lower.
Car loans are also a lot more flexible than they used to be. Some allow extra repayments, and redraw may even be available. And by using a car loan, you keep different debts separate to gain a clearer picture of your overall finances.
The key is to speak with your Mortgage Choice broker to know which is the right strategy for you – accessing home equity or using a car loan to fund your next car.
1 Calculation based on rate of 3.67% (lowest on Mortgage Choice panel) and term of 30 years using loan calculator at https://www.mortgagechoice.com.au/home-loans/calculators/home-loan-repayment-calculator.aspx