Don’t fall for a common debt trap by borrowing against your mortgage to buy your next car. It’s an easy choice, but Brad Dale, Executive Director of Automotive Financial Services (AFS) says:
“Financing a short term asset using a long term debt instrument like a mortgage is a debt trap.”
“By lumping your car loan onto your mortgage you think you’re saving money because the interest rate you’re paying on your home loan is much lower, say 6 to 7 cent for the standard variable rate” he says.
“However, financing a depreciating asset alongside your home, which is generally appreciating in value, covers up the true cost, particularly the residual debt after you’ve sold the car.”
“The average term for a car loan is almost 5 years but over half of all car loans are paid out within 2 years because of selling or trading in.” says Dale “Car affordability has increased over the past decade and manufacturers keep tempting us with new models, so car turnover is high.”
“The true cost of borrowing against your mortgage is hidden in any residual debt that remains after you’ve sold or traded in your car. You can still be paying for the car you bought two or three cars ago if you don’t pay down your mortgage by the outstanding balance of debt. This can often be much higher than the trade-in value you might get when you upgrade your car.”
AFS calculates that you may actually pay over 30% interest on the amount you borrow for the car. That’s about five times the standard variable rate of 6% you’d expect.
It’s clear from the figures: On a typical mortgage of $300,000 at 6.5%, over 30 years you will pay $382,632 in interest. For a car loan of $15,000 at 12.95%, over five years you will pay about $5,455 in interest.
By increasing your mortgage by $15,000 you will pay an additional $19,131 in interest, which equates to a rate of 38.75%. * example excludes any fees or charges.
The interest cost is compounded even further if you purchase a more expensive car or finance other cars in the household using your mortgage.
“Whilst the headline rate may give you the impression you’re saving money, in reality it’s probably the most expensive financial mistake you’ll ever make. The only winner is the bank, which has you on the hook for longer” says Mr. Dale.
"If you've got a house, this doesn’t mean you can’t borrow for a car against it but you’ll need to increase your repayments so that you can fully repay the amount borrowed for the car within the period of ownership. Then you can be sure you benefit from the lower mortgage rate. It just needs some planning and discipline," he says.
“It’s worthwhile talking to your accountant or a financial advisor and shopping around to explore all the finance options available and choose the one that’s right for you.”