By Virgil Zetterlind
If you’re in the market for a recreational boat, you know by now that a boat (even a used boat) can turn out to be the most costly purchase you’ll consider apart from your house. Because of the size of boat purchases, making an informed decision can save you big when it comes to boat financing. We outline below several of the larger decisions to be made in considering a boat loan, such as basic boat loan types, insurance, depreciation of value, and taxes. We’ve included the basics (and even some of our own helpful personal anecdotes), but please consult a professional for more comprehensive information before making a decision.
1. What’s My Budget?
Before considering your boat financing options, you’ll want to know what you’re looking to finance! Start with a realistic budget and stick to it. This budget must include more than just the loan payment. Consider downpayment, boat storage costs, upkeep and repairs, insurance, gas, and anything else related to using your boat. Even a new boat under warranty will likely require non-covered service in the 1st year. Once this exercise is complete, you should have a good idea on what your allowable monthly boat finance cost will be.
You also need to consider what you can reasonably expect to borrow. In today’s market, this tends to be more than is wise, but there may be cases where existing debt, income, or credit history limit your options. A check of your credit rating and score is a good idea – as this will also have a bearing on your boat loan options and interest rate.
2. What are My options?
With a budget in mind, you can now consider the basic loan types. We will cover each in general here before getting into specifics on each type.
Collateral Boat Loan- Similar to your basic car loan, a collateral boat loan uses your boat’s value as the lender’s security. Loan terms and rates vary widely – typically 15 years from 25-100K, and then over $100K, 20 years can become available. Most collateral loans require a 10-20% downpayment (although we’ll discuss no-money down options later).
Home Equity Boat Loan- Given the rise in home values over the past few years, the home equity loan has been a popular method for boat financing. In this case, you are borrowing against your home – leaving you a clear title on the boat. As a home loan, interest charges are normally Federal income tax deductible which lowers the effective interest rate a bit. Home equity loans come in 2 principle types: the Line-of-Credit and the Fixed.
The Collateral Boat Loan
Interest on a boat loan may be tax deductible under the “2nd Home” deduction if the boat includes cooking, sleeping, and bathroom facilities (i.e., at least a stove, bunk, and port-a-potty). Many of the newer small cuddies now include a stove for this very reason. Lenders will require you purchase and maintain full insurance on your boat – so be sure to consider this in your cost equation.
For new boats, standard loan terms allow financing up to 85-90% of the total purchase price plus tax, registration, and extended warranties. For buyers with excellent credit (~730+) some lenders will offer no-money down loans, but these can be risky due to depreciation. With used boats, loan terms depend on the age and value of the boat.
The Home Equity Boat Loan
Given the boom in home values and until recently low interest rates, home equity loans have grown more common as ways to finance recreational purchases. Interest on home equity loans is generally tax-deductible, which is attractive for boats that would not otherwise qualify. Rates are generally set by the “Loan-to-Value” (LTV) ratio, which is simply the amount you owe on your home divided by your home’s total value.
To borrow against the value of your home, a home appraisal may be required. This is more likely if you are requesting a high LTV loan or you claim significant appreciation over a short time period. The best rates are for LTV’s less than 75-80% and many lenders will cap boat loans to around 80%.
Home equity boat loans are more likely to require closing costs than collateral boat loans. Costs can vary between lenders, but are generally a few hundred dollars and may include appraisal fees. Competition between lenders does lead to reduced closing costs or waived costs – especially if the loan is held for at least 3-5 years. When we shopped around in the spring of 2006, home equity rates were running about a 1/4 to 1/2 percent higher than boat loan rates.
The Line-of-Credit Boat Loan
Line-of-Credit (LOC) loans do not initially have fixed terms. They act a bit like credit cards in that you have a “limit” to borrow against, but only pay interest on the amount borrowed at any given time. Under an LOC boat loan, you may be able to make interest-only payments in the early years. LOC’s are quite popular for lenders since the open-ended terms and interest-only payments yield bigger profits in the long run—as such most lenders offer no-closing cost options for new LOC’s. The LOC’s interest rate is normally variable and is based on the prime lending rate – meaning that as rates rise, the lenders also make more money. In the consumer’s favor, most LOC’s can be “converted” to a fixed loan at some future point – but keep in mind that if rates have risen significantly, you can be caught with a lot of debt.
The Fixed Home Equity Boat Loan
The fixed loan operates like a traditional mortgage or boat loan in that the borrower has a fixed payment term and interest rate. Rates are often a bit (~1/2 point) higher than the LOC (remember that in the long run you’ll likely still save compared to the LOC) but will not change over the course of the loan.
3. How do I choose a boat loan?
How long do you plan to own the boat? – The #1 consideration boat ownership is Depreciation (followed closely by maintenance costs)! New boats lose value very quickly – easily 20% in the 1st year alone. In a soft market, such as this summer with high gas prices, it can be difficult to sell even a bargain priced boat, so be sure your boat loan works with your time frame.
As an example, we purchased our 2001 Regal at about 40% of MSRP against a new 2005 model and only 60% against the best-deal out-the-door cost of the 2005 cruiser. If you are uncertain about how long you’ll have the boat, make that 20% downpayment on the boat loan to give yourself some price flexibility.
How much is your home equity? – We believe the home equity loan is best considered when you can keep the LTV ratio under 70%, are reasonably stable in your current location, and can get competitive rates and terms against a normal loan. If home prices soften substantially, a high LTV home equity loan could leave you without a downpayment on another home if forced to move for a job or other unexpected reason. Home equity is the largest financial “safety net” for most Americans, and you don’t want to borrow too much against it. You may own your boat free and clear, but it’s a lot harder to get an emergency boat financing against a used boat than against a house (which historically appreciates rather than depreciates).
We’d stay away from a LOC loan, except for small amounts which can be paid off quickly. A fixed term also protects against future sticker shock when the LOC’s interest-only payments stop.
If you’re looking to buy an older “project” boat, home equity may be your only option if you can’t afford cash. Older boats can be great deals – just be sure to do your part in establishing value prior to the purchase. Try to anticipate major repair or restoration costs also.
What’s your exit strategy? – Have an out if you need to suddenly sell the boat. Your best position is to owe much less than it’s worth. Expect that most boats take time to sell.
As we discussed in the home equity section, home equity gives you the boat free-and-clear, but may put you in a more difficult position in an economic downturn (it really depends on your individual situation). Don’t deplete your cash reserves in the initial purchase as even new boats will require a lot of investment in upkeep and provisioning. Some claim as high as 5-15% of the purchase price to outfit a new boat with equipment.
Finally, we suggest you carry full insurance. A minor accident can total a boat – leaving you with no boat and a big loan. Watch for depreciation clauses which can drastically reduce your payout on older boats. If your boat is young (usually around 5 years or less), you can often get “agreed value” or even “replacement” coverage for a bit extra for added financial safety. Make sure your insurance terms match your boating environment (offshore limits, season limits, hurricane deductibles, …).
Conclusion
We hope you’ve found this article informative. Boat buying can be a big step, but we’ve found the family experiences invaluable. Remember to fully explore your boat financing options, and thanks for reading!
Virgil Zetterlind gained his ‘sea legs’ as a midwestern transplant to the Florida Panhandle while serving in the Air Force. His family quickly outgrew their 1st boat, a 19′ Chaparral Cuddy, which led to their purchase of a 28′ Regal Express Cruiser (and his experiences related to boat financing in this article). In 2006, Virgil founded DestinSharks.com to share his family’s experiences with boating and to explore the use of the then-new program Google Earth for marine applications. He is currently a Founder and Chief Technology Officer for EarthNC, Inc – Marine Charts for Google Earth thus keeping boating at the center of his work and play.