Q: I am interested in obtaining a home-equity line of credit on my home to purchase
a car. I have at least $200,000 of equity and would like to borrow about $40,000.
Since the interest would be tax deductible, is this a common method for homeowners to finance big-ticket items, such as vehicles? Is this something that you would recommend?
A: You have two questions. Let me answer the first one.
My experience leads me to think that taking out a home-equity line of credit in order to purchase a vehicle is not common, but certainly not unusual. With good credit, most homeowners can obtain a HELOC with an interest rate equal to the prime rate. (The prime rate is a benchmark rate that banks charge for a variety of personal and business loans.)
With the prime rate currently at 4 percent, such a loan is not a bad deal.
So why aren’t more people taking out HELOCs to buy cars? Well, for one thing, the Big Three automakers have been selling new cars with sweet financing deals for several years. In fact, you can probably find an advertisement on television or in the newspaper every day that pushes “Zero-percent financing available.”
Even with the tax deductibility of a 4 percent HELOC, it won’t beat a zero-percent loan. As long as the automakers continue to offer sweet financing deals, the use of a HELOC to finance a new car will be fairly uncommon.
Another reason that I have noticed is that homeowners, by and large, are financially responsible. Many homeowners object to taking out a long-term loan to pay for a depreciating asset.
Most HELOCs allow terms of up to 30 years with thefirst 10 years allowing interest-only payments.
Here’s an example. Let’s say you take out a $40,000 HELOC at 4 percent to buy a new BMW. The interest payment on $40,000 at 4 percent is only $133 per month. Fantastic — a new BMW is costing you only $133 per month.
So you buy your BMW and make the payments for the next seven years. The BMW wears out and you realize that your HELOC balance has not dropped a penny because you chose to make interest-only payments. Now you are $40,000 more in debt and you need a new car.
One thing I haven’t mentioned is that the prime rate is at the mercy of the Federal Reserve Board. When Chairman Alan Greenspan raises short-term interest rates, as he is expected to do, the prime rate will also rise.
Now, having said all that, you might be surprised when I answer your second question.
Yes, in certain circumstances, I would indeed recommend purchasing a new vehicle with a prime-rate-based HELOC. The reason is simple: It’s cheap money. Four percent is cheap.
If no incredible financing alternatives are offered by your auto dealer, a HELOC will surely allow you to borrow inexpensively, with the deduction.
Taking out a HELOC for this purpose must come with some responsibility.
Understand that the prime rate is likely to rise at some point. We don’t know for certain when or by how much.
If you choose to make interest-only payments, make sure you have enough money in your savings account to pay off the HELOC when you dispose of the vehicle. As I said, you don’t want to create long-term debt to pay for a depreciating asset.
If you don’t have the ability to pay off a HELOC that is used to finance a car, make sure your HELOC payments include enough principal every month so that the HELOC will be paid down to zero when the vehicleis discarded.
The prime rate will be rising this year. It’s anyone’s guess as to whether it will rise to the level that would drive homeowners away from the HELOC market.
Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail (firstname.lastname@example.org).