You probably never thought that purchasing a new car could impair your ability to get a mortgage for a home. It’s one of several moves that you should consider carefully before applying for a big loan.
Mortgage lenders will be taking a deep dive into your financial history to make sure you can handle the payments, and a large, newly acquired debt load will weigh against you. So if you’re serious about buying a house, think carefully before going fast and furious on a car purchase that requires a loan.
“If you were to line them up, your mortgage is typically one of the largest purchases you’re ever going to make, and so you want to make sure you’re in the best possible position,” says Melissa Rich, vice president of residential lending at Draper and Kramer Mortgage Corp.
Below are some of the financial factors mortgage lenders consider, and how taking out a car loan can affect them.
Adding any new credit line or loan can affect that sacred credit score.
“Whenever you take on an installment loan [like a car loan] or open a new credit card, the credit bureaus will immediately make a hard inquiry on your credit report,” says Rich. “The purpose is they want to see over a couple of months how you as a consumer will respond to this new line of debt—are you going to handle it responsibly?”
Rich says this is not a negative over the long term, but in the short term it can drop your credit score a few points, which, as a result, can affect your ability to qualify for a mortgage and land the most favorable rate.
“One of the most important factors in determining your home budget is your debt-to-income ratio, or DTI,” says JJ Lester, a certified financial planner and options and real estate specialist at Personal Capital.
Your DTI is your monthly debt payment divided by your pre-tax monthly income. If your debt obligations are higher than the money you earn, you look riskier to lenders.
“When you take out a car loan, it goes against your income and eats into that debt-to-income ratio, pulling down your buying power in terms of what you can afford,” says Rich. Ultimately, if you have a significant car payment to make every month, it could affect whether you qualify for a mortgage or the amount you can borrow.
Lester says your front-end DTI is the percentage of your gross monthly income that’s spent on housing costs, which lenders typically require to be no more than 28% of your gross income. Your back-end DTI is the percentage of your gross monthly income that goes to all debt payments, like your mortgage, credit card, and other loans, which lenders generally require be no more than 36%.
The two most common big purchases people make in their lifetime are a new car and home, but timing is everything.
“We always advise people that it is ideal to wait and make other big purchases, such as a car, after they close on the home,” says Rich.
She says when considering buying a home and a new car, it’s best to talk to your mortgage lender first.
“Outline what your time frame is for buying a home and what the car loan would be, and ask how the car purchase will impact the numbers the lender is running for you,” says Rich. “Yes, things could change, but it’s better to be prepared and make an informed decision based on possible scenarios.”
Experts say payment history is one of the most vital pieces of information when determining your creditworthiness. Therefore, a long car loan payment history can actually increase your credit score and show lenders you’re capable of making payments on time. This is one way a car loan can actually help you get a mortgage.
But when a new line of credit, like a car loan, is opened, it can lower your credit score because it lowers the length of your overall credit history.
“If you go out and get a car loan tomorrow, and then want to buy a house in the next month you, you haven’t allowed enough time to show you will handle that line of debt responsibly,” says Rich. That’s why it’s smart to allow enough time to elapse between getting a car loan and applying for a mortgage.
Rich says for some people it can take two months for an installment loan to have a positive impact on their credit, while for other people it can take six months or more.