Auto loan vs home equity loan what is the difference

By Izzy M
Modified on January 29, 2024
auto loan vs home equity loan

When you need money to pay unexpected bills, you can use your assets as collateral to secure fast cash! Auto loans and home equity loans are two financing options that provide a lump sum. But when it comes to an auto loan vs. home equity loan, which is better? Learn both advantages and disadvantages of deciding between an auto loan vs. Home equity loan today!

What Is an Auto Loan?

An auto loan is an installment loan option that borrowers can use to purchase a new or used vehicle. You can get an auto loan at the dealership you intend to get the car or find an online lender. Borrowers can pay off the auto loan through fixed monthly installments for a specific duration. During the repayment process, the lender holds onto the car title. Once the borrower fulfills the auto financing agreement, the lender removes their name from the pink slip and hands it over.

Eligibility for an auto loan depends on your credit score and income. Borrowers with low credit scores can qualify for auto loans, as there are auto loans for bad credit online. Unfortunately, the repayment terms will be less than ideal. Although, you can increase your chances of getting loan approval by inquiring about a joint auto loan. For example, if your spouse has excellent credit, their credit score is used for the joint auto loan. Using a cosigner lowers the financial risk for the lender and increases your chances of qualifying! 

What Are the Pros of an Auto Loan?

Many borrowers use auto loans to afford the high cost of a new or used car. Check out some of the pros of auto loans below. 

You Can Build Equity

The benefit of an auto loan is that you are paying to own the vehicle. There is good and bad debt. An auto loan is a form of good debt because you are working to pay off a car purchase. Once the auto loan is paid off, you become the sole owner of a valuable asset! In a sense, you can trade total loan balance for a higher score! Car owners can trade in vehicles for quick cash or get a trade allowance for a different car! Certain states even offer deductions for trade-ins when calculating sales tax. A sales tax deduction can help you save money on the purchase of a new vehicle! 

Extended Repayment Terms

You can get potentially get years to pay off the auto loan! An extended repayment length can result in low monthly payments, so you can easily afford your existing monthly bills. However, remember a long repayment period will result in more interest fees. If you apply for an auto loan, ensure the lender has no prepayment penalties. Otherwise, you have to pay a hefty fine for paying off the auto loan early. 

High Loan Amounts

Vehicles have high price tags, but eligible borrowers can get thousands of dollars with car loans! If the lender sees you have good financial habits on your credit report, you can get enough money to purchase that dream car. Individuals with less-than-perfect credit can still get sufficient money, although not the maximum loan amount. 

What Are the Cons of an Auto Loan?

Auto loans are a convenient option when you need fast cash to buy a vehicle, but there are a few downsides. Read about some of the cons below. 

Strict Spending Rules

One of the cons of an auto loan is that they have strict spending rules. Borrowers can only use auto loans to buy a specific new or used vehicle. If you need money for other expenses, you will need to obtain a different type of loan. 

High-Interest Rates

If your credit score is not good, you can get stuck with excessively high-interest rates. While collateral reduces the financial risk for the lender, they may still mitigate risk with a high-interest rate. When loan rates are too high, paying monthly payments on time can be challenging. Many borrowers who end up in a debt spiral mention high rates as one of the reasons they struggle with repayment. 

Financial Risk

Auto loans come with financial risk because you secure funding using the vehicle. If you experience personal finance issues during the repayment process, you can lose your car! When a borrower falls behind on their monthly payments, the auto loan lender has the legal right to initiate a repossession. Depending on your state laws and the financial agreement, the lender can come onto your property to repossess your beloved car. Repossessed vehicles are then sold at auction to cover the unpaid loan balance.  

What Is a Home Equity Loan?

A home equity loan allows homeowners to take out a second mortgage on their house. Suppose you have sufficient equity in your house. In that case, you can apply for a home equity loan to get thousands of dollars in financial relief! Lenders base loan amounts on the difference between your home’s current market value and your current mortgage balance. 

Qualification for a home equity loan depends on your credit score, income, and the equity in your home. When you apply for home equity loans, the financial institution will require an appraisal. An accurate home appraisal protects the lender from the risk of default. In addition, accurate assessments prevent the borrower from owing more than the property is worth. 

There are three types of home appraisals: 

  • Automated valuation method (AVM)
  • Walk-through appraisal
  • Drive-by appraisal

The amount of time it takes for a lender to conduct an appraisal and the type of appraisal done depends on the lender.

What Are the Pros of a Home Equity Loan?

Home equity loans can be a fantastic option for borrowers who own real estate property. Read about some of the advantages of home equity loans to make a fully informed financial decision. 

No Spending Restrictions

Borrowers can only use auto loans to purchase a specific vehicle, which is inconvenient. But borrowers can use a home equity loan for almost any expense! Borrowers use their home equity loan to make home renovations, consolidate debt, pay wedding expenses, and even buy a car. You have the freedom to use the money from a home equity loan to purchase anything!

High Loan Amounts

Real estate is worth a lot of money, so you can likely get more money than you need with a home equity loan! A home equity loan is a great option when you need cash and don’t want to settle for a cash-out refinance. Eligible borrowers could get thousands of dollars if they have a decent amount of equity in their house. 

Decent Interest Rates

If you want to know which option is more affordable between an auto loan vs. a home equity loan, know that home equity loans tend to have lower interest rates. Most financial institutions offering home equity loans have fixed rates, so your loan payments will not change month to month. Decent fixed-interest rates could help you save money overall.

What Are the Cons of a Home Equity Loan?

While home equity loans are a convenient loan option for homeowners, there are a few downsides you should be aware of.  

Financial Risk

Much like auto equity loans, home equity loans pose a financial risk for the borrower. In the event you fall behind on monthly loan payments and default, the financial institution can foreclose on your house! Secured loans allow more people to qualify for the emergency cash they need but at the cost of their personal property. Carefully consider how much risk you are willing to take to get a loan. 

Closing Costs

One of the main disadvantages of a home equity loan is the closing costs. Borrowers must pay closing costs to obtain a mortgage, home equity loan, or home equity lines of credit (HELOCs). While home equity closing costs are lower than mortgage closing costs, you may still have to pay a significant amount. Home equity loan borrowers can typically expect to pay 2% to 5% of the total loan amount.

Long Approval Process 

If you need financial relief quickly, you may have to settle for a different loan option than a home equity loan. The approval process for home equity loans can take up to two months! Why? Home equity loans require an underwriting process, a thorough appraisal, and a lot of documentation. While you can get a lot more money with home equity loans than with an auto loan, you cannot get it right away.    

Auto Loans vs. Home Equity Loans: Which Is Best?

When it comes to an auto loan vs. home equity loan, the best option for you depends on how much you need, when you need it, and what you want to spend your loan money on. 

While you can potentially get thousands of dollars with an auto loan, you may only use the loan money on a car purchase. An auto loan can help you build equity if you need cash for a vehicle. Once you pay off the car, you gain a valuable asset. Car owners can trade or sell the vehicle in the future to get emergency cash. Best of all, certain states allow deductions for trade-ins when calculating sales tax.

Home equity loans have more significant loan amounts and no spending restrictions, but the approval process can take months! If you need an equity loan to buy a new furnace, you may need to scout other financial options. 

Auto and home equity loans are beneficial financing options for different reasons. But make sure you also explore alternatives to traditional loans. No matter which loan you apply for, ensure you compare lenders and loan offers. To ensure the loan will fit into your existing budget, use financial calculators to get an estimate of your monthly loan payments. 

Home Equity Loans and HELOCs Come With Closing Costs│NextAdvisor

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