Q. I need a new car and it will cost about $32,000. I have $25,000 in cash. Should I use the cash and take out a small car loan or use my home equity? Or what combination? I have good credit so it shouldn’t be hard to get a loan.
— Borrower
A. It’s a tough job to find a new car these days, as a semiconductor chip shortage is hurting supply.
But if you find the wheels you want, there are several factors at play here.
Keep in mind that the specifics of your financial situation and goals should have an impact on your decision, but here’s what you should consider.
When deciding whether to use cash or take out a loan for a purchase you will want to consider the opportunity cost of your decision, said Deva Panambur, a fee-only planner with Sarsi, LLC in West New York and an adjunct professor of personal finance at Montclair State University.
You said you have $25,000 on hand.
Ask yourself: If you did not use the cash to purchase the car, what would you do with it? How does the cost of the loan compare with the return you would get if you were to invest the cash?
Also, does your financial situation and cash flow situation allow you to take on more debt and is your credit score good enough to get a relatively low-cost loan?
“Not all factors are objective, there are some subjective issues to consider,” Panambur said “For example, some people do not like to take on more debt and some others will want to use cash to create an emergency fund for unexpected situations if they don’t have one.”
In general, he said he does not recommend taking out a home equity loan unless it is to improve your home because you don’t want to ever be under the burden of the debt on your home.
There are a few other reasons for this recommendation, he said.
“The interest rate on a home equity loan will likely be higher than the interest rate on a mortgage since a home equity loan is usually a second loan on your house,” he said. “It could also be higher than the interest rate on your car loan, especially if you buy a new car from a dealer.”
Also consider that the Tax Cuts and Jobs Act of 2017 limited the tax deductibility of interest on home equity loans only if the loan is used to “buy, build or substantially improve the taxpayer’s home that secures the loan,” he said.
So if you use the proceeds of the loan to purchase a car, the interest on your loan is not deductible, just as the interest on your car loan is not deductible.
Although you did not ask this question specifically, you will also want to decide whether to purchase a new car or a used car.
“Usually, if you are planning for the long term and are not particular about driving a brand new car, buying a used car makes better dollar sense because cars depreciate rapidly in the first few years,” Panambur said.” Therefore, a used car has more ‘mechanical value’ than the price suggests.”
“However, because of unusual dynamics in the car market, for some car brands, new cars may be better value than used cars,” he said. “These dynamics are also impacting the buy versus lease equation so you will have to do your research before you make your decision.”
Email your questions to Ask@NJMoneyHelp.com.
Karin Price Mueller writes the Bamboozled column for NJ Advance Media and is the founder of NJMoneyHelp.com. Follow NJMoneyHelp on Twitter @NJMoneyHelp. Find NJMoneyHelp on Facebook. Sign up for NJMoneyHelp.com’s weekly e-newsletter.
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