Auto Loan vs. HELOC - Marginal Tax Rate Advantage?

Reply Sat 15 Feb, 2014 07:18 pm
I'm in the early stages of considering a new or used car purchase, since we've gotten just about the true worth out of both of our now 19 year old vehicles (although I suspect that both of them could still go a little bit farther . . .).

This isn't exactly in the category of "high finance", since the loan amount is nearly negligible and there's no actual question of our ability to qualify for either loan or to repay what's being borrowed. I'm pretty sure I know the answer, but given that I can get a used car loan, with an APR of 2.28%, and a home equity line of credit (HELOC) "loan" with an APR of 2.75% - aren't I better off going with the HELOC, since the interest on that loan amount is tax deductible?

I'm pretty sure I should be able to figure this out myself, but let's just assume that I take out a loan in the amount of $10,000, and with a repayment period of 24 months. Let's also assume that I'm in the tax bracket with a 25% marginal tax rate.

Under the car loan scenario, you would pay interest in the amount of: $239.23

And under the HELOC scenario, you would pay interest in the amount of: $288.97.

So, given the $49.74 difference in interest paid, can't I determine which loan is more advantageous, given my 25% marginal tax rate (yes, this is the point where I start getting confused . . .). Thanks!
Peter Frouman
Reply Sat 15 Feb, 2014 11:18 pm
Yes, assuming you were able to deduct the entire amount of the interest paid, the HELOC didn't have any closing costs or additional fees and the terms of the vehicle purchase were the same for both options, you would probably be better off with the HELOC.

The calculator at http://www.bankrate.com/calculators/mortgages/loan-tax-deduction-calculator.aspx indicates that the effective rate with the 2.75% HELOC would be 2.063% (after taking into account the mortgage interest deduction) which is less than the 2.28% for the car loan.

However, there are some other variables to consider:

Any closing costs or fees for the HELOC would probably make the car loan a better choice. Most lenders don't charge any closing costs for HELOCs but some do. Of course, this is not an issue if you already have the HELOC.

The car loan will be better if you don't have enough deductions to itemize and have to take the standard deduction.

Mortgage interest is not deductible under all circumstances. see http://www.irs.gov/publications/p936/ar02.html

The law could change so that mortgage interest is no longer deductible. This is very unlikely to happen (it has been proposed as a federal deficit reduction measure but is strongly opposed by powerful interest groups) but it is a risk.

If your financial circumstances changed and you were unable to make the loan payments, you would risk losing your house if the loan was a HELOC while you would only risk losing your car if it was a car loan.

A HELOC usually takes longer to process and fund than a car loan. For example, in Texas there are legally required waiting periods which mean a minimum of 17 calendar days must pass between the HELOC application date and the funding date. In contrast, a car loan can often be approved and funded the same day.

Reply Mon 17 Feb, 2014 10:28 am
@Peter Frouman,
Okay, this all sounded right, and intuitively (and maybe at least slightly arithmetically . . .), I think I already knew this to be the case, but now Peter Frouman, has confirmed all that.

While nothing in the future is for certain, I think I'll place in the Not Likely To Occur column:

● The mortage interest law will be revised or revoked
● I won't have sufficient deductions to be able to itemize my tax deductions for the foreseeable future
● There's a reasonable likelihood of losing my job, and consequently defaulting on the HELOC, and we would lose our house

This was (all) good, and now others will potentially benefit, especially from the nifty online Bankrate calculators (which I should have been able to calculate myself, if only I had paid attention in school). Thanks!
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