Carol is considering the purchase of a new car. She can obtain a car loan from the
dealership at a rate of 6.5%. Alternatively, she can take out a home equity loan and use
the proceeds to buy the car. The rate on the home equity loan is 9%. Interest payments
would be tax deductible on the home equity loan, but not on the loan from the
dealership. If Carol is in the 30% marginal tax bracket, which financing choice should
she make? (Assume the transaction costs associated with the two loans are similar in
size.)

Question

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The Answer of Carol is considering the purchase of a new car. She can obtain a car loan from the
dealership at a rate of 6.5%. Alternatively, she can take out a home equity loan and use
the proceeds to buy the car. The rate on the home equity loan is 9%. Interest payments
would be tax deductible on the home equity loan, but not on the loan from the
dealership. If Carol is in the 30% marginal tax bracket, which financing choice should
she make? (Assume the transaction costs associated with the two loans are similar in
size.)

Carol Is Considering the Purchase of a New Car