HELOC to pay off car loan: Is it a smart move?

The HELOC, or home equity line of credit, is a versatile way to finance many things. People often choose HELOCs to finance home improvements or consolidate debt because of their flexibility, potentially lower interest rates than unsecured debt, and initially lower payments. 

HELOCs allow you to borrow up to your credit limit and use the proceeds for almost any purpose, including purchasing or refinancing a car. However, it's not generally a good idea to use a HELOC to pay off a car loan. 

Before you decide, consider the drawbacks and how they might impact your financial situation. Let's dive into the potential pros and cons.

What does it mean to use a HELOC to pay off a car loan?

When you pay off an auto loan with a mortgage loan like a HELOC, you're moving your risk from your vehicle to your home.

Auto loans are secured by your car, meaning your vehicle is the collateral. If you stop paying your loan, the lender could repossess your vehicle and sell it. Auto loan interest rates are nearly always fixed, and you typically repay the loan in equal monthly installments. 

When you refinance (pay off) your car loan with a HELOC, your loan is no longer tied to your car. Instead, HELOCs are secured by your home. Failure to repay a HELOC puts your home at risk for foreclosure.

Here are other things you should know about HELOCs:

• HELOC interest rates are often variable, which means your rate and payment can change. Some HELOCs allow you to fix your interest rate at one or more times during the loan term. These are called fixed or convertible HELOCs. 

• They're broken into two phases: the draw period and the repayment period. You can borrow, repay, then borrow again up to your limit as much as you want during the draw period. The repayment period stops your ability to borrow more and you focus on paying off your balance.

• With a HELOC, some lenders allow you to make interest-only payments during the draw period. This won't reduce your balance any, however, and you could see a huge jump in your monthly payments when the repayment period starts.

• HELOCs typically come with longer repayment terms than auto loans, which tends to make their payments lower. It means you take longer to pay off your debts, though.

Some HELOCs may offer lower rates than auto loans—but it's far from guaranteed. It won't make sense to pay off your auto loan with a HELOC at a higher rate in most cases.

Can you use a HELOC to pay off a car loan?

If you qualify for a HELOC, you can use it for many things—like consolidating higher-interest debt, big-ticket purchases, home improvements, or starting a business. And yes, you can definitely pay off a car loan with a HELOC. 

Just because you can doesn't mean you should. First, understand the advantages and drawbacks. Then, apply them to your situation to make a good decision.

Why some homeowners consider a HELOC to pay off a car loan

There could be valid reasons for using a HELOC to pay off a car loan: 

• HELOC rates could be lower than those of auto loans in some cases. If you can get a lower rate, a HELOC might save you money.

• HELOC repayment terms tend to be longer than auto loans, which could mean a lower monthly payment.

• HELOCs can be used for many purposes. Homeowners who are taking one out anyway may choose to include their auto loan to simplify their debt management. 

No matter why you want to refinance your auto loan with a HELOC, have a solid repayment plan so you don't put your home at risk.

What are the risks of using a HELOC to pay off a car loan?

While refinancing a car loan with a HELOC could make sense for some, it's not right for most people. Here are the top reasons using a HELOC to pay off a car loan could be risky:

• Your home, not your car, is at risk if you can't make the payments. And home foreclosure is a more serious problem than losing your car.

• HELOC rates and payments could increase if you have a variable rate loan or if you make interest-only payments during the first years of the loan. 

• Stretching out your auto loan repayment with a longer-term HELOC could lower your monthly cost but increase your total interest expense. This could easily happen even if your interest rate is lower. 

• HELOCs aren't free. Most require lender charges, appraisal fees, and/or other closing costs. These could offset or even wipe out any savings offered by a lower rate.

• You're losing equity in your home. You're trading home equity for vehicle equity, and vehicles rarely hold value over time. Plus, if property values drop your home could be worth less than you owe on your mortgage and HELOC. This could make it harder to sell or refinance.

Don’t downplay these risks when you decide if paying off a car loan with a HELOC is right for you.

How to compare a HELOC vs. your car loan 

Before committing to a HELOC, it’s good to understand the cost of keeping your auto loan as-is versus the cost of a HELOC car loan refinance. You may choose to use an online HELOC payment calculator, and it's a good idea to run these numbers so you understand both loans.

You'll need this information:

Your car loan today

• Remaining balance

• Remaining number of months on your loan 

• Monthly payment

• Interest rate

The HELOC offer

• Interest rate and how/when it can adjust

• Loan fees and other closing costs

• Ongoing fees

• Repayment term

• Minimum payment

• Full payment

Compare in plain terms

• Monthly payments. If your HELOC has a variable interest rate, consider your starting payment but also your worst-case payment. If you can convert your rate to a fixed loan, compare that payment as well (include any conversion fees). 

• Total interest paid. Compare how much your current auto loan will cost you in interest between now and when you'd pay it off. Then, figure out the total cost of the HELOC between now and when you'd pay off the balance from your car loan. Compare those numbers to see which would save you the most money.

• Fees and other uses. If you're only getting the HELOC to pay off your auto loan, add any loan or ongoing fees to your total cost. However, if you're getting the HELOC for other things and want to pay off your auto loan while you have it, you might discount the loan fees.

• Amount you can afford to pay each month. You'll save the most money and keep your risk lower if you can afford to pay off the HELOC quickly.

This analysis should help you figure out if refinancing will accomplish your goal—whether that's reducing your interest expense or lowering your payment. You'll also get a good look at the potential risk and cost of changing your loan. 

When might using a HELOC to pay off a car loan make sense?

It’s not generally recommended, but replacing your auto loan with a HELOC could make sense in certain circumstances:

• The HELOC interest rate is much lower than your auto loan rate, even accounting for loan fees.

• You can get a HELOC with a fixed rate and payment that won't change.

• You can afford the full (not interest-only) monthly payment.

• You’re taking out a HELOC to consolidate debt or for other reasons, and it makes financial sense to also borrow enough to pay off the car. 

• You have stable income and a clear payoff plan to minimize foreclosure risk.

• You understand the terms of the new loan and are comfortable with a worst case scenario.

When should you think twice?

While everyone wants the lowest rate or payment possible, it may not be worth chasing. Here are reasons to avoid refinancing a car loan with a HELOC:

• Your auto loan rate is already low.

• The loan fees exceed the potential savings.

• Your finances are rocky. Unstable income, no emergency savings, or little wiggle room in your budget could make it difficult to pay your HELOC, putting your home at risk.

• Foreclosure risk makes you uncomfortable.

• You might move soon or undertake major life changes.

• Your total costs will increase.

• You would need to use up a significant amount of home equity. If your home drops in value, it could put you underwater on your mortgages.

Another consideration is the useful life of your car. If it's got five years of life left, do you really want to spend 15 years paying it off?

Alternatives to consider

HELOCs are fine loans when taken out for the right reasons, but one of these options might be better for you if you're dealing with auto debt: 

• Refinance the car loan. You may be able to improve on the terms of your loan without risking your home or incurring closing costs.

• Accelerate your loan repayment. Pay extra when you can to clear your balance faster and lower your interest costs.

• Prioritize expenses and negotiate debts. Possible tactics include settling unsecured debts to lower your monthly costs and free up money for your car loan. 

• Contact your auto lender for hardship assistance. Some forms of aid could be payment deferrals, extensions, reduced interest rates, or loan modifications.

Summary: Is a HELOC to pay off a car loan worth it?

For most people, the HELOC isn't the best way to finance or refinance a car. The costs and risks just don't work. You could make the right decision by looking for the best HELOC terms available to you. Then compare them to your current auto loan and figure out if a HELOC makes sense.

A HELOC to pay off your car loan may not be right, but you could still work through your alternatives. A debt consultant, loan officer, or other professional may be able to help if you're overwhelmed by the options.