By on February 16, 2009

One of our Best and Brightest wrote an insightful comment on how NOT to buy a car in another thread. I asked flashpoint to expand on his advice for your edification.

If you purchase a car using your Home Equity Line of Credit (HELOC),  it only makes sense to do so if:

#1 you are in excellent financial standing with excellent credit standing;

#2 you have a steady occupation with little risk of being laid off; and

#3  the entirety of the car price can be paid off with the HELOC.

It does not make sense to max out your HELOC on a vehicle unless it pays the entire amount of the vehicle. For example, buying an $80,000 BMW by using $40,000 of HELOC and financing the rest is a bad idea, because you end up not only paying the loan for the car + interest, but the Heloc + interest rate is added to your other debts.

This is a recipe for failure and has led to numerous people winding up behind on their bills, in foreclosure and forced into bankruptcy and liquidation of their personal assets.

The theory behind buying a vehicle using HELOC is that you will circumvent the interest rate of an auto loan. It makes sense if you are wealthy or disciplined, but there is risk involved.

First of all, if you buy the car with cash, you own it. A car is a depreciating asset and it loses value quickly in today’s market.  If you find yourself requiring cash later on, you’d be forced to sell the vehicle at a reduced priced just as you would if you had leased or financed. However, if you have a credit standing good enough to finance at low interest, over the long term, you have more choice in what to do with the vehicle without the upfront expense of basically adding a second mortgage payment to your home’s burden.

If you’re struggling with large credit card balances or have problem credit, a home equity loan might not be right for you.

Not everyone can make use of the mortgage-interest deduction when filing his or her income tax return, but if you’re using the deduction now on your first mortgage, odds are you’ll be able to use it on your home equity loan, too. IRS Publication 936, Home Mortgage Interest Deduction 6, lays it all out. Talk to a tax professional if you’re still not sure.

By being able to deduct the interest expense, you reduce the effective rate of interest on the loan. The interest expense on a conventional auto loan isn’t tax-deductible.

Bankrate’s national average for a HELOC is 8.09 percent and 7.8 percent for a home equity loan. The national average for a three-year auto loan on a used car is 8.88 percent. If you’re in the 25-percent marginal federal income tax bracket the effective rate on the HELOC is about 6 percent.

A HELOC is a variable-rate loan, and the interest rate is normally tied to the prime rate. Since the prime rate moves in lock step with changes in the targeted federal funds rate, and that rate has been rising steadily for more than two years, it takes a bit of courage to sign up for a HELOC to finance your car.

In contrast, a home equity loan will have a fixed interest rate, and the loan payments are self-amortizing, meaning the payments are large enough to pay the interest expense and pay off the loan over the life of the loan. In the early years of a HELOC, its required loan payments are interest-only, and you have to have the financial discipline to make principal payments, too.

I also suggest you be very wary of people who suggest you buy into programs such as Ufirst’s MMA.

The gist of this system is that you can reduce your mortgage lifespan by paying it off faster and paying less interest.

I have a friend who pimps these “computer software” MMAs for $3000 a pop. The problem is that a HELOC can be called at any time by a US bank. They reserve the right. If you max yourself out and your HELOC gets called, you can be in some serious shit.

I recommend that you reserve HELOC for home improvement not plasma TVs or sound systems . . . I mean home improvements such as flooring, roofing, etc. HELOC’s purpose is to be around just in case your house springs a leak or a major repair comes up. It should not be treated as a piggy bank or a credit card.

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29 Comments on “The Truth About Using a HELOC to Buy A Car...”


  • avatar
    John Horner

    “HELOC’s purpose is to be around just in case your house springs a leak or a major repair comes up.”

    I agree, almost. In the old days, these were called home improvement loans. Home improvement remains the only good reason to take a loan out against your property. If, however, you are taking loans out against your home for routine repairs then you are probably living in a more expensive house than you can really afford.

  • avatar
    GS650G

    HELOCs should be treated as emergency funds first, not creative financing tools for second homes, boats, cars, etc. And only if you have a lot of equity, like over 50%, since a price crash in your neighborhood may bring an unwelcome letter to your door.

  • avatar
    TireGuy

    You should advise that no one takes out this type of loan. That such loans were available in the US has contributed to the financial crisis. HELOC loans worked only in the bubble market, where the house prices went up – and this was a sure thing for desaster, once that climb stopped.

  • avatar
    TEW

    I am convinced that using a HELOC to buy a car is a very bad idea. If you fail to pay the car note they just take your car but if you fail to pay the HELOC you lose your house. Why take that risk? I wish more articles like this were around when the housing boom was going on. Maybe unsecured debt would not have been transferred into a home loan.

  • avatar
    Detroit-Iron

    I also suggest you be very wary of people who suggest you buy into programs such as Ufirst’s MMA.

    I thought you were saying people shouldn’t get talked into fighting in the UFC. Then I looked it up: http://www.istockanalyst.com/article/viewarticle/articleid/1965733

  • avatar
    no_slushbox

    This would have been good for people to know three years ago. Right now someone that even qualifies for a HELOC based on their credit and loan-to-value ratio is a unicorn.

    If I were king I would ban ARMs, cash-out refinances and HELOCs on residential properties, and require 20% down, but unfortunately I am not king.

    In the short term this would NSFW-up property values even more, but in the long term it would prevent a crisis like this from ever happening again.

    Bankers would whine that I am limiting consumer choice (i.e. their ability to rip off stupid people), but when the shit hits the fan I have to bail-out the bankers and the gullible homeowners while I get no relief on my on-time 30-year fixed.

    Also, the next time a conservative throws a hissy-fit about “consumer choice” being limited by a paternalistic government – marijuana, crack-cocaine, and heroin are legal, right?

    We live in a society where it is impossible for the losses to not be socialized, so it’s time to put a limit on the two-bit risky scams that can be run to get the returns.

  • avatar

    The Problem I see right now is that A LOT of mortgage Brokers and Bankers are hurting and out of work. They have infiltrated other financial systems with the skills they acquired cooking up the current crisis and are trying to make their money back.

    when I was in Mortgaging years ago, we made LEGITIMATE LOANS and were pulling down $10,000 – $30,000 a MONTH IN COMMISSION.

    Now you’ve got brokers used to living like CEO’s who are busting their asses in low paying financial service jobs who are trying to regain what they lost.

    BE CAREFUL WHAT THEY TRY TO GET YOU TO SIGN UP FOR.

    I get offered HELOC’s, CREDIT CARDS, CAR FINANCING, etc and never asked for it.

    Some people right now are getting cheated because they were locked into high interest ARM loans years ago and now they are attempting to refinance to government backed loans – but the problem is UNEMPLOYMENT is rising and even when people refinace they are still defaulting on their loans. The current default rate of this category is higher than 50%.

    HELOCS should be saved for sudden, unexpected, major repairs that a house might need – and only if you don’t have the cash to pay it.

    If you must refinance, try for government backed loans.

    If you are attempting to be a first time home buyer – go for an FHA loan.

    Every effort should be made to pay OFF (not down) credit card debt.

    Bankruptcy should be the last option. Its an Emotional decision – not a financial decision.

    I disagree with people who think this little bit of info I’m offering would have been enough to help us avoid this crisis years ago. It goes alot deeper than that. Bush was using the mortgage industry to prop up the economy in the face of the billions we burned through in the wars. The reason it came crashing down is because banks like Fannie and Freddy BUY THE LOANS from smaller banks in order to free up the smaller banks to make more loans. The real problem is, they added securities to the loans and made them STRUCTURED INVESTMENT VEHICLES to be sold worldwide to the highest bidders internationaly.

    When people started losing jobs or the payments on their ARMS adjusted – the defaults started and the debts snowballed into infinite/unpayable debt strings.

    This year, when ARM loans reset again, foreclosures are going up again. I expect foreclosures to be higher than 500,000 unless tha government intervenes.

  • avatar
    jpcavanaugh

    Once upon a time, at least up until the late 80s, all interest was deductible for anyone who itiemized. Home mortgage, car loan, credit cards, student loans, all of it. Then, the deduction went away for all interest EXCEPT for home mortages. IMHO, this planted the seeds for the current credit mess. The mortgage industry started to sell the concept of your home as a piggy bank, and the only source of tax deductible interest. The result is more and more people with no equity in their homes, even after living there for 15 or 20 years.
    The cure: All interest should be treated equal. Either give a tax deduction or don’t, but treat all interest expense the same. Personally, I would end the home mortage deduction and reduce the rates, but this is a debate for another forum.

  • avatar
    mel23

    The game was failing even before job losses began. I was watching the real estate market closely, and found a website run by the real estate board of a region fairly close to me. Among the data they released on a monthly basis were number of sales, average selling price, inventory and new listings. The number of sales held steady as did the average selling price. What foretold the end coming was inventory. As inventory climbed, it meant greater choice and more time on the market per sale. So this put pressure on the sellers to cut their price, and when that started, the game was over. Pretty quickly, the real estate board stopped posting the data. I assume the facts got in the way of their bullshit about a strong market. Of course conditions varied in different markets. I think it was Greenspan saying the models he used assumed there would not be a national down trend in real estate markets; real estate markets are local. Guess he slept through the ’90s.

  • avatar

    I think the destruction of Equity in American homes is due specificaly to the FED pumping capital in the system after 9/11.

    #1 Houses were reasonably priced, around $180,000 for a decent 1 fam home.

    #2 The Fed makes it easier to get credit after 2001

    #3 Because its easier to get credit, it becomes easier to buy cars and houses which allows people to own multiple homes – this causes supply to drop, demand to rise and the price of the homes to rise accordingly.

    the amount of the homes rise… You ask to take out MORE money from the bank which causes the values of the homes to rise MORE which causes you to attempt to take out MORE money.

    You end up paying $570,000 for a house that was worth $165K just 10 years ago. And because of the self interest of the brokers to get the sale accomplished, you end up with TWO MORTGAGES totalling that $570K

    My friend DAWN got hit like this and ended up just walking away from her property.

    #4 with housing prices now inflated, and mortgage brokers offering numerous, vague, products such as ARM, COSI and Pick-a-payment loans, Homeowners make stupid choices with their equity to finance other things such as second homes, cars or investments.

    #5 the bubble bursts and equity starts decreasing while the amount of the payments exceeds the actual value of the home…ARM loans begin resetting and people can’t afford the sudden jups in payments.

    #6 People start abandoning homes.

    #7 Mortgage defaults cause banks to begin going into bankruptcy

    #8 as homes are abandoned, home values plummet causing the inflated equity to plummet accordingly.

    #9 people are left with no equity in their homes – yet, high mortgage balances to pay off.

    #10 Now…

  • avatar
    RickCanadian

    “HELOC’s purpose is to be around just in case your house springs a leak or a major repair comes up. It should not be treated as a piggy bank or a credit card.”

    I learnt that from Mum & Dad when I was a kid. As a consequence, I never had a fancy $80K car and never will, but my kids will have a roof over their heads. I call that a good bargain.

  • avatar
    wsn

    I see nothing wrong with using a HELOC to buy a car.

    For me, my interest rate on my HELOC is 3% as of now. Instead of paying 7% to the car dealer, I can pay cash (from HELOC) and demand a sizable cash discount.

    HELOC is just like everything else (cars, alcohol, woman). It can be dangerous if you abuse it. But it’s a good thing if you know what you are doing.

    BTW, HELOC is NOT the root cause of this sub-prime crap. The Federal Reserve is. The Fed provided unlimited amount of low interest loans to interest groups, thus totally distorted market economy.

    In a real free market, there should not be a Fed. If people want to get a loan, the loan will have to originate from another person’s saving, not from the Fed (yeah the banks got their money from Fed). If people try to borrow money and flip houses, the interest will immediately sky-rocket because the savers will demand that. And thus a bubble could be prevented. But then Fed existed, provided money supplies that never should have existed and punished all savers. The savers couldn’t beat the borrowers and thus joined them, to form a larger bubble.

  • avatar
    no_slushbox

    “Bankruptcy should be the last option. Its an Emotional decision – not a financial decision.”

    That’s a good catch-phrase, but not true. The decision to declare bankruptcy can be based on sound financial reasoning or emotional stupidity, just like many decisions; it is not inherently an emotional decision or even a last resort.

    Say I am a UAW worker in the Detroit area. I have no significant money in the bank. My personal property falls under the exemption limits. My income falls under the Chapter 7 cutoff. I owe $15K on a $10K car. I owe $200K on a $150K house.

    Chapter 7 is obvious for that person. The pension is exempt. Job certainty is low. Everything he has is worth less than what he owes on it. He has no assets for the court to take. His credit will be temporarily shot, but what does he want to buy on credit anyway, it’s smarter to rent in his area.

    This is the last resort:

    http://www.thetruthaboutcars.com/porsche-high-stakes-poker-claims-a-life/

  • avatar

    WSN

    I believe the reason the gold standard was abolished, and the FED was created was to make it possible for America to create infinite debt to finance war. A gold standard wouldn’t support internetional warfare or the military industrial complex.

    I mentioned the FED’s doing in my last comment.

    But again…don’t blame the FED. Blame the American voting public.

    If we all decided we wanted the FED dissolved and we only voted for people with the caveat that they ended the FED – then either they would get into office and end it, or the public would be smart enough to vote against them in favor of someone more on the people’s side.

    I feel the American public has no common goal and each is concerned with his own interests and ideaologies which is why this system remains forever deadlocked.

  • avatar
    Pch101

    Bankruptcy should be the last option. Its an Emotional decision – not a financial decision.

    There are a lot of people out there who probably avoid bankruptcy because of emotion. There are people who hang in there, paying bills that they have no hope of paying, for whom BK would be a better option.

    HELOC is NOT the root cause of this sub-prime crap.

    Wrong. The mortgage industry sold that lie in order to avoid culpability and to allow their white overleveraged borrowers to feel better about themselves.

    It isn’t just a subprime problem, as events clearly indicate. Prime defaults now surpass subprime defaults. Loan default rates are soaring across every product type and among every class of borrower.

    Many Americans are a few paychecks away from losing their homes. That is an unacceptable situation, but it is only possible because loan-to-value restrictions were tossed out the window.

    Low-down payment loans were a recipe for disaster, and now we’re enjoying the meal. There are few consumers in the US today who have enough financial knowledge to justify having a variable rate loan, let alone a HELOC. The average person is in no position to forecast interest rates or property values, or to pay for the consequences when their bets go sideways.

    Once this crisis is over, these loans should all be made illegal for home purchases. If you’d like to pull the equity out of your home, then get it the old-fashioned way — sell your house.

  • avatar
    Axel

    List of things you should spend a HELOC (or any other home equity cash-out) on:

    1. Home repair and improvement.

    There, that was easy.

  • avatar

    PCH 101
    HELOC’s ARE NOT the root cause of this situation.

    If you take a good look at most loans defaulted on, HELOCS are probably not in the picture…more likely the problem is SECOND MORTGAGES or ARM LOANS.

    The real cause is deregulation in government allowing Wall Street and bankers to run wild and without discipline in the granting of loans. Not to mention the FED who basically answers to no one.

    Whoever came up with the NINJA (no income,no jobs or assets) type loans should be exectuted.

    I don’t believe HELOCS or ARMS should be illegal – they just need to be enforced in regards to explaining truthfully to the buyer what they are signing up for.

    Here in NY, nearby Hempstead right now has tremendous foreclosures because the influx of Hispanic immigrants there qualified for loans they could not possibly afford – to buy homes with no money down. Many of them got TAX ID’s which allowed them to quickly build a credit rating… imagine going from 0 Fical – 750 in just 2 years???? I’ve seen it.

    They got into the place on credit alone and simply defaulted on it when the loans set up to buy it reset. Many never even made the first payment.

    Furthermore, mortgage were used to LAUNDER DRUG MONEY – what better way do you have to hide half a million dollars?

    On top of that, many people were busy FLIPPING HOUSES – something barely talked about nowadays.

    I have a friend who used to make $16,000 a month who bought two houses – to flip one – and sucked the equity out of both as soon as he closed the contract.

    There was a 25 year old in fact who used his credit rating to purchase over 10 houses – sucking out the equity – and made himself a millionaire in a couple of months.

    Unfortunately, too many people argue that the cases I’ve pointed out are part of FREE MARKET CAPITALISM and should not be infringed on.

    I disagree. This is irresponsible and the GOVERNMENT SHOULD BE INVOLVED TO KEEP IT FROM HAPPENING EVER AGAIN.

  • avatar
    willbodine

    May I suggest a #4?

    4. That your equity in the property being HELOCd is greater than 50% of estimated value.

  • avatar
    Kevin

    Not everyone can make use of the mortgage-interest deduction when filing his or her income tax return, but if you’re using the deduction now on your first mortgage, odds are you’ll be able to use it on your home equity loan, too.

    And here my friends is exhibit A in why well-meaning government policy itself has been a major contributor to the current economic crisis. Straight mortgage-interest deductability is questionable enough, the way it distorts markets, but giving people a backdoor means to also pile on credit card and auto debt in this deductible bucket — that absurd.

    The government is not encouraging home ownership — just the opposite it’s inducing people to trade away home equity for more debt, which is precisely what has happens every time someone takes out a HELOC. The government is simply subsidizing and encouraging consumer debt.

    And worst of all, suckering people into waiving the consumer protections that normally mean you don’t lose your home if you default on a car loan or credit card — here’s a swell idea, let’s bet the house that I’ll be able to make payments on that BMW I can’t afford.

  • avatar
    Robert Schwartz

    You would not sell your house to buy a car. Don’t put yourself in the position of having to do it to avoid foreclosure.

  • avatar
    TireGuy

    Kevin :
    February 16th, 2009 at 3:04 pm

    Not everyone can make use of the mortgage-interest deduction when filing his or her income tax return, but if you’re using the deduction now on your first mortgage, odds are you’ll be able to use it on your home equity loan, too.

    And here my friends is exhibit A in why well-meaning government policy itself has been a major contributor to the current economic crisis. Straight mortgage-interest deductability is questionable enough, the way it distorts markets, but giving people a backdoor means to also pile on credit card and auto debt in this deductible bucket — that absurd.

    The government is not encouraging home ownership — just the opposite it’s inducing people to trade away home equity for more debt, which is precisely what has happens every time someone takes out a HELOC. The government is simply subsidizing and encouraging consumer debt.

    .

    You are absolutely right – the chance to deduct interest from your income leads to peoply going into debt on purpose, thereby defying the idea of bringing people to own their houses. If Government really wanted to help peaople owning their houses without inducing them to go into debt, it can simply allow a house owner to write off the investment into the building e.g. over a period of 25 years. Thereby, whether you pay cash or finance, you have the same tax result – and this leads people to use the method which is more efficient to them, namely paying off the debt – which is a must if you want to really own your house.

  • avatar
    wsn

    TireGuy said:

    If Government really wanted to help peaople owning their houses without inducing them to go into debt, it can simply allow a house owner to write off the investment into the building e.g. over a period of 25 years.

    But, unfortunately, that if statement is false. The government policies are not intended to help people owning their houses. Instead, they are intended to help their Wall Street friends to make more money from loan interests during good time, and make more money from bailouts during bad time.

    If you think I am too cynical, why not just check out what kind of deal did Paulson give to Goldman Sach and where did Paulson work prior to his appointment.

  • avatar
    CarShark

    I watched CNBC’s “House of Cards” retrospective on the housing bubble. My personal favorite: stated income applications without verification. I know that not every schmuck lied and said he made eleventy billion last year, but why would you open yourself up to that?

  • avatar
    TireGuy

    wsn :
    February 16th, 2009 at 5:21 pm

    But, unfortunately, that if statement is false. The government policies are not intended to help people owning their houses. Instead, they are intended to help their Wall Street friends to make more money from loan interests during good time, and make more money from bailouts during bad time.

    If you think I am too cynical, why not just check out what kind of deal did Paulson give to Goldman Sach and where did Paulson work prior to his appointment.

    I believe that the initial goal in fact was to assist people buying houses – although certainly the politicians were happy that Wall STreet was making money on this as well. In any case, the interest deductibility was much older than the Subprime loan wave which initiated this.

  • avatar
    Jonathan I. Locker

    Right now, my HELOC rates are just about even with my auto loan rates.

    I just got an auto loan for 48 months at 3.99% from my credit union (for a used car). It would be very difficult for a HELOC rate to be much lower. And with a rate that low, why put your home at risk.

    If you stop making payments, you get to drive free for a few months before they repo your car…rather than repo your house. For 1 or 2 points of interest, I think that is worth the protection.

  • avatar
    dulcamara

    Most of us for whom getting a car with an HELOC makes sense pay the AMT, and can’t deduct the interest. This means an HELOC makes sense for nobody. I have 80% equity in my home; I’m 57 years old; I’m the HELOC poster child. But, the AMT puts this on my “don’t touch” list.

    The god fearin’ republicans did nothing for my tax burden. May they burn in hell for eternity.

  • avatar

    Jonathan I. Locker : I just got an auto loan for 48 months at 3.99% from my credit union (for a used car). It would be very difficult for a HELOC rate to be much lower. And with a rate that low, why put your home at risk.

    My heloc is currently at 2.25% and with the tax deduction is effectively .25%. I am a small business owner and I used my Heloc to buy two used vehicles. While they have depreciated I can always sell them for cash to pay down my heloc if necessary.

  • avatar
    Jonathan I. Locker

    mjposner,

    You indicate that your HELOC rate is at 2.25%, which is an amazing rate. But If you are in the 28% tax bracket, the effective rate is really 1.62%.

    And don’t forget that most HELOC’s are variable depending on the current prime rate. There is always a chance that in a year or two interest rates could go up, wiping out any savings you had over the fixed auto loan.

  • avatar
    deanst

    “Since the prime rate moves in lock step with changes in the targeted federal funds rate, and that rate has been rising steadily for more than two years, it takes a bit of courage to sign up for a HELOC to finance your car.”

    Huh? Fed funds peaked in the fall of 2006 and has been falling ever since. Did you mean to say that at its current level of .25 it only has room to increase?


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