Have you ever had the pleasure of being stuck at home with 2 children under 3 and not being able to leave the house? My friend Debbie recently faced this problem, their car had broken down and it was going to cost more to repair it than the car was worth.
What would you do if you were faced with not being able to get out of the house for weeks on end?
Having to ask family and friends to give you a lift to the shops so that you can buy the necessities for the family.
You have to purchase a new car, but how? The most common options would be:
- If you have the savings just go and buy a new car,
- Get a personal or car loan to buy a new car, or
- Us the equity in the home loan to purchase the new car
The first option wasn’t possible, while Debbie and her husband had some savings it wasn’t enough for the new car. Hence let’s have a look at the other two options.
To keep things simple lets assume the new car is worth $30,000 and Debbie was going to borrow the whole amount. Since their home was valued at $400,000 and the home loan balance was $220,000. They had plenty of equity which can be used to purchase the new car.
Car Loan
Assuming an Interest rate of 10% and a loan term of 5 years.
The Monthly repayments on a loan of $30,000 would be $637.50
Cost over the life of the loan would be $8,245 in interest.
Home Loan
Interest rate of 5% over 25 years
The monthly repayments on the home loan would increase by $175.5 to cover the car.
Cost over the life of the loan would be $22,615 in interest.
From this you can see that taking out the car loan is the better option. However there is another option.
Home Loan with Car Loan repayments
If we redo the home loan scenario, but instead of just paying the minimum repayments we increase the repayments by what the car loan repayment would be.
The monthly repayments on the home loan would now increase to $637.50
The cost in interest until the car was paid off would now be $3,460, a saving of almost $5,000. The car would now be paid off in full in 4 and a half years.
Furthermore if we continued paying off the home loan at the higher repayments the home loan would be paid off 9 years sooner. Thus saving a whopping $75,000 over the life of the loan.
Consequently by using the equity available in the home loan, not only can they save money but they would own their home sooner.
Back to Debbie and her family. In the end, Debbie’s mother-in-law came to the rescue and lent them the money to buy a new car.
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