09 Jan I need to buy a new car. What’s the best way to finance it?
Q. I need to buy a new car and I don’t have cash available. What are the pros and cons of taking money from a HELOC or a 401(k) loan, or just taking a large car loan?
— Looking around
A. You’ve got a lot of options to fund a car purchase, but just remember the car loses lots of value the moment you drive it off the lot.
Let’s go over your choices.
There are benefits in using the equity in your home as collateral for some other type of spending, said Bill Connington of Connington Wealth Management in Fairfield.
He said you may get a lower interest rate with the HELOC.
But there are downsides, too.
First, under the new tax law, you can no longer deduct HELOC interest unless the funds were used to purchase, build or renovate your home. It used to be that you could deduct HELOCs no matter how you spent the money.
Also, HELOCs can be unpredictable because they may have variable rates that can leave you paying more than you anticipated, Connington said.
But the biggest danger with either option is the risk to your home.
“With a conventional auto loan, the vehicle itself is the collateral. But with either a home equity loan or HELOC, the collateral is your home,” he said. “If something happens and you can’t make the payments, your home could be in jeopardy. That’s a big risk to take for an auto loan.”
It’s possible to borrow money from your 401(k), but there are significant negatives.
The first is opportunity cost — the lost earnings on the capital you withdraw.
The repayment, generally limited to five years or less, comes straight out of your paycheck, which may tempt you to reduce your regular 401(k) contribution. That’s another long-term opportunity cost, Connington said.
“If you lose your job or change plans, you may have to repay the balance in full within 60 days,” he said. “Then, if you don’t repay the loan at all, you face taxes and early withdrawal penalties. That could put a big dent in your nest egg by the time you retire.”
He said car loan rates are low and the old theory is if you are earning more on your investments than what you are borrowing, then let your money work.
So take another look at your options before you take the plunge.
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This story was originally published on Jan. 9, 2020.
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