Buying a Car: Auto vs. Home-Equity Loans

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Record oil prices, a bear market, and six months straight of nationwide job cuts have many folks tightening their budgets.

But some consumers have no choice but to consider buying a new car, whether they're looking for better fuel efficiency or their old jalopy finally bit the dust. Regardless of the reasons, if you're in the market for a new car, you should choose the type of financing that will keep your costs as low as possible.

Many people finance a new car purchase via either a home equity loan or an auto loan. But there are a few key numbers to consider when choosing between the two types of loan. They offer different interest rates and closing costs, and they have very different tax implications: Interest paid on your home equity loan may be tax deductible, while interest on a car loan is never deductible.

The two loan types also carry different risks: Using equity in your home to purchase a car puts your home at risk if you default on your loan. If you default on an auto loan, meanwhile, you only put your car at risk.

Balancing the added risk against the potential savings from a home equity loan's lower rates (in general) and tax savings can make for some difficult math. But the number-crunching is a little easier with the help of the online loan calculator from BankingMyWay.com.

To use the calculator, you need to input the amount and term of the loan, the rates for both the home equity and auto loans and any sales tax, fees and closing costs that apply. You also have to enter your federal and state tax brackets because of the tax savings from the home equity loan.

Let's say you live in South Carolina, and you are looking to buy a $20,000 car with no down payment and a 60-month loan. Home equity loan and auto loan interest rates in South Carolina recently averaged 7.232% and 7.335%, respectively. (You can check out up-to-date loan rates in your area at BankingMyWay.com.) And while closing costs vary greatly from lender to lender, you should expect to spend one percent of your loan or less.

With that scenario in mind, you stand to save $1,034 over five years by going with the home equity loan, assuming you're in the 25% federal and 4% state tax brackets. The bulk of those savings stem from the tax benefits of the home equity loan -- benefits that you may not realize if you don't itemize your deductions. In fact, your monthly payments on the home equity loan are actually $3 more than they'd be with the auto loan. But the $1,210 in potential home equity loan tax savings is enough to cover this difference and still net a significant savings.

But a home equity loan won't always be the right choice. Borrowing against too much of the equity in your home could mean you'd have to pay for private mortgage insurance (PMI). PMI payments would quickly eat away at any potential savings from a home equity loan. And remember that you create additional risk to your home if you choose the home equity loan. Putting your home in jeopardy for just a few hundred dollars in savings may not make financial sense.

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