You probably never thought that buying a new car could interfere with your ability to get a mortgage on a home. This is one of the many things you should consider carefully before applying for a large loan.
Mortgage lenders will take a deep look at your financial history to make sure you can handle the payments, and large and newly acquired debt will weigh against you. So, if you are seriously considering buying a home, think carefully before you go fast and furious about a car purchase that requires a loan.
“If you were to line them up, your mortgage is usually one of the biggest purchases you’ll ever make, and so you want to make sure you’re in the best possible position, ”explains Melissa Rich, vice president of residential loans at Draper and Kramer Mortgage Corp.
Below are some of the financial factors that mortgage lenders consider and how taking out a car loan can affect them.
Adding a new line of credit or a new loan can affect that holy credit score.
“Every time you take out an installment loan [like a car loan] or open a new credit card, the credit bureaus will immediately investigate your credit report thoroughly, ”says Rich. “The goal is that they want to see over a few months how you, as a consumer, will react to this new line of debt – are you going to manage it responsibly? “
Rich says it’s not negative in the long run, but in the short run it can lower your credit score by a few points, which, as a result, can affect your ability to qualify for a mortgage and get the most advantageous rate.
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“One of the most important factors in determining your home budget is your debt-to-income ratio, or DTI,” says JJ Lester, Certified Financial Planner and Options and Real Estate Specialist at Personal Capital.
Your DTI is your monthly debt payment divided by your monthly pre-tax income. If your debt securities are higher than the money you earn, you seem riskier to lenders.
“When you take out a car loan, it goes against your income and eats away at that debt-to-income ratio, reducing your purchasing power in terms of what you can afford,” says Rich. In the end, IIf you have a large car payment to make each month, it could affect your mortgage eligibility or how much you can borrow.
Lester says your initial DTI is the percentage of your gross monthly income 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 towards all debt payments, like your mortgage, credit card, and other loans, which lenders typically require no more than 36%.
The two most common big purchases people make in their lifetimes are a new car and a new home, but timing is everything.
“We always let people know that it’s ideal to wait and make other big purchases, like a car, after the house is closed,” says Rich.
She says when she plans to buy a house and a new car, it’s best to talk to your mortgage lender first.
“Describe what your home buying schedule is and what the car loan would be, and ask yourself what impact buying the car will have on the numbers the lender comes up with for you,” says Rich. “Yes, things could change, but you better be prepared and make an informed decision based on the possible scenarios. “
The duration of your car loan
Experts say payment history is one of the most essential pieces of information in determining your creditworthiness. Therefore, a long auto loan payment history can actually increase your credit score and show lenders that you are capable of making payments on time. It’s one way a car loan can 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 shortens the length of your overall credit history.
“If you go out and get a car loan tomorrow, and then want to buy a house next month, you don’t have enough time to show that you’ll manage that line of debt responsibly,” says Rich. That’s why it’s a good idea to allow enough time between getting a car loan and applying for a mortgage.
Rich says that for some people it can take two months for an installment loan to have a positive impact on their credit, while for others it can take six months or more.