If I hadn’t had the cash on hand, I would have considered three options to finance the new car:  an auto loan, a home equity loan, or a home equity line of credit.

I compiled the rates offered for the three types of loans by four local banks, as listed in the table below.

Auto Loan

An auto loan is likely the most common way to finance the purchase of a new car.  It tends to have the highest rate, but if you don’t own a home, it might be your only option.  The good news about an auto loan is that there are usually no closing costs and the paperwork is straightforward.  The bad news is that the interest paid isn’t tax deductible.

Home Equity Loans

If you have sufficient equity in your home, you can borrow against it.  The home equity loan and home equity line of credit are similar, but different, beasts.  We’ll tackle the home equity loan first.

You can typically borrow up to 80% of the equity in your house.  For example, if your house is worth $200,000 and you have a $140,000 mortgage, then you have $60,000 in equity.  You can borrow up to 80% of the equity or $48,000.

The interest paid on a loan secured by your primary residence is tax deductible. Some exceptions apply, so read the fine print, but for most folks, it will be deductible.

One disadvantage of a home equity loan is that there are closing costs, similar to those paid for a mortgage.  The fees can be as high as a few percentage points of the loaned amount, and these fees can eliminate much of the advantage of the tax savings.  Also, the loan is secured by your home.  Should you not pay off the loan, your home could be at risk.

Home equity loans are intended for the purchase of a relatively expensive item, such as a car, and typically charge a fixed rate of interest.

Home Equity Line of Credit (HELOC)

A HELOC is similar to a home equity loan, but the interest rate is variable.  The initial interest rate for a HELOC is typically lower than that for a home equity loan, since the borrower is assuming more of the risk associated with fluctuating interest rates.  The HELOC was designed to be available for relatively frequent use, so it is more like a credit card, rather than a one time loan.

As with home equity loans, you can typically borrow up to 80% of the equity, there are closing costs, interest paid is tax deductible, and the loan is secured by your home.

Comparing Overall Costs

The chart above shows the rates offered for the three loan types at four banks in my local area.  It also shows the monthly payment for each loan type using the average interest rate and assuming a four-year (48 month) loan per $10,000 borrowed.   The chart also shows the total amount paid over the life of the loan, and separates out the interest portion.  The next line shows the tax deduction you would receive, assuming you are in the 28% tax bracket and that your deductions are not limited.  The final line compares the overall amount  saved as compared to a conventional auto loan.

Summary

The good news is that you have many options to choose from to finance your new wheels.  The bad news is that you have to choose from many options.  The right choice depends on whether you have enough equity in your home,  the interest rates offered, closing costs, and your tolerance for the paperwork that comes with loans secured by real estate.

Full disclosure: No positions