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Loan Loser: Home-Financing a Car

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By Michelle Singletary
Sunday, March 18, 2007

Would you take out a 30-year car loan?

Okay, 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 the purchase of a car 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 automobiles grew in the last decade as interest rates dropped and property values soared. It also has become popular as lenders hype the fact that interest on a home loan is tax-deductible, unlike interest on a vehicle loan.

In 2006, about 24 percent of homeowners used a home equity line of credit to purchase a car or truck, according to Synergistics Research, a financial services market research company based in Chamblee, Ga. About 8 percent of homeowners took out a second mortgage specifically to buy a vehicle, says William H. McCracken, chief executive of Synergistics.

But is buying a car or paying off your remaining auto loan balance with the borrowed equity from your home a good financial move?

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

The assumption people make is that the home equity loan is cheaper than a traditional car loan because of the mortgage interest tax break. However, 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, erasing any savings on your taxes. Plus, because the car money is rolled up in a home mortgage, you could still be paying on a loan for a vehicle you've long since sold or traded in.

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 http://www.bankrate.com/compare.

So let's look at one example of an auto loan versus 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, according to Bankrate.com), your monthly payment would be $604.85. Over the 60 months of the loan 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 significantly lower at $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 in today's dollars (not including estimated loan costs of $500).

However, if you don't itemize your taxes to get the interest deduction and you fail to make extra payments every month, you end up paying $13,450 in interest, a difference of $7,158.89, according to Taylor's calculations. Under that scenario, and even with the tax deduction, the auto loan is cheaper.


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© 2007 The Washington Post Company

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