A car is the first major purchase in life for many Canadians and often requires the help of a car loan to finance such a big purchase. And when it comes time to buy a house, those hefty car loan payments will leave less money left over for mortgage payments. But does having a car loan affect getting a mortgage?
Key Points
- Buying a car can affect your ability to buy a house in several ways, including increasing your debt, reducing your cash reserves, and potentially affecting your credit score.
- Mortgage lenders will look at your overall financial picture, including your income and debt.
- You should only apply for a mortgage if your finances can comfortably handle additional mortgage payments on top of all other debts you’re responsible for paying.
Can A Car Loan Affect Your Ability To Get A Mortgage?
Your car loan can have a significant impact on your ability to get approved for a mortgage to buy a home, depending on your income and debt levels. Your income can only be split in so many ways. If there’s not enough money left over after making car loan payments and paying all other bills, you could have trouble securing a mortgage.
Understanding your current financial situation can help you determine whether buying a car is a good idea right now, especially if you’re planning to purchase a home in the near future.
While your income is one of the main factors that mortgage lenders look at when determining whether to approve a mortgage application, your overall debt is also assessed. If a big chunk of your income is already dedicated to paying off your current bills, adding another loan payment to the mix might be too much for your finances to handle.
Before you buy a car, consider the potential effect an additional monthly payment may have on your ability to get approved for a mortgage.
How Does Buying A Car Affect Buying A House?
Mortgage lenders have specific lending criteria that borrowers must meet to be eligible for a mortgage. For instance, lenders typically insist that borrowers meet specific income, debt, and credit score requirements to reduce their risk.
Lenders want to know that you’ll be able to make your mortgage payments on time every billing cycle and that you won’t default on the loan. For example, if you want an insured mortgage, the CMHC restricts debt service ratios to 39% (GDS) and 44% (TDS).
Gross Debt Service (GDS) Ratio
Your Gross Debt Service ratio refers to how much of your gross monthly income is dedicated to paying your monthly housing costs and plays a key role in your ability to secure a mortgage, or any other type of loan. Generally, lenders prefer to work with borrowers with a GDS ratio of no more than 39%.
To calculate your GDS ratio, divide your monthly gross income by your monthly housing costs. Then, multiply by 100.
For instance, if your monthly income is $7,000 and your housing costs are $2,000, your GDS would be 28.6% ($2,000 ÷ $7,000 x 100). This ratio falls well below the maximum threshold.
Total Debt Service (TDS) Ratio
Your Total Debt Service ratio refers to all your debt payments in addition to your housing costs relative to your income. Additional debt payments can include things such as credit card payments, student loans, personal loans, and so forth.
In general, your TDS ratio should be no more than 44%. Anything higher than that would increase the lender’s risk, which could reduce your chances of loan approval.
Your TDS is calculated by dividing your monthly gross income by your total debt, including housing costs. For example, if you earn $7,000 and your total debt adds up to $3,000 per month, your TDS would be 42.9%, which would be under the maximum level that landers typically allow.
How Your Car Loan Affects Your Debt Service Ratios And Your Mortgage Affordability
By adding a car loan to your debt, you’ll be increasing your debt service ratios, because more of your income will have to go toward paying your debts. Unless your income increases to offset the additional loan payments, a car loan could get in the way of your ability to get a mortgage.
Adding a car loan to your debt load will reduce your overall mortgage affordability. Unless you start earning more shortly, a car payment will cut into your earnings and leave less left over for other loan payments, including a mortgage.
For instance, let’s add a prospective car loan payment to the above example:
- Gross monthly income: $7,000
- Total debt (not including housing costs)
- Total debt (including housing costs): $3,000
- Additional car loan payment: $600
| Without Car Loan | With Car Loan | |
| Gross Income | $7,000 | $7,000 |
| Total Debt (Not including housing costs) | $1,000 | $1,000 |
| Housing Costs | $2,000 | $2,000 |
| Car loan payment | None | $600 |
| GDS ratio | 28.6% | 28.6% |
| TDS ratio | 42.9% | 51.4% |
In this case, your car loan would add another $600 to your monthly debt, which would add up to $3,600 per month. Using these figures, your TDS would come to 51.4% ($3,600 ÷ $7,000 x 100), which is over the limit of 44%. This ratio could make you overly risky for the lender, who may be hesitant to approve your mortgage application.
If your finances are strong, a car loan itself may not necessarily derail your chances of successfully buying a house and securing a mortgage. However, it could impact the loan amount you wish to take out or the interest rate your lender offers you.
How Your Car Loan Can Affect Your Credit Scores And Mortgage Approval
Your credit score can impact your ability to secure a mortgage. Ideally, your credit score should be at least 660 to 680 or higher to minimize the lender’s risk and increase your chances of getting approved for a mortgage.
When you take out a car loan, your credit may be affected. This, in turn, can affect your ability to get approved for a mortgage and the interest rate you’re offered.
Here are some ways your car loan can affect your credit:
Credit Check
Your lender will conduct a “hard inquiry” of your credit report to assess your creditworthiness when you apply for a car loan. This could cause your score to be a bit too low to get the mortgage you need if you apply right after purchasing a car.
Payment History
A history of on-time car loan payments can be very good for your credit score, as payment history plays a key role in credit health. And a good credit score can help you get approved for a mortgage. That said, it takes time to build a positive payment history, so having a car loan won’t immediately increase your credit score.
On the other hand, if you’re late making your car loan payments, your credit score will be negatively affected.
How Your Car Loan Can Affect Your Cash Reserves And Mortgage Affordability
Buying a car often requires a down payment upfront, which can be a few thousand dollars. This can significantly reduce the available funds that you would need to make a down payment on a mortgage and cover closing costs.
Mortgage lenders will look at your cash reserves when determining your ability to secure a mortgage. If they feel that you don’t have enough liquid cash available, this could impact the mortgage loan amount you can get, or whether you can qualify for a mortgage at all.
Should I Buy A Car Or A House First?
Your decision to buy a car or a house first depends on a few things, such as your income, credit profile, and lifestyle needs.
Buy a house first if …
- You’re financially stable
- You have sufficient funds for a sizable down payment
- You have a strong credit score
- You want to build long-term wealth
- You want to get into the housing market before home prices and interest rates increase
Buy a car first if …
- You have minimal savings
- You need immediate transportation requirements
- You live in an area where a car is necessary
If you decide to buy a car first, consider the fact that vehicles depreciate in value quickly. If finances are an issue, consider buying a used vehicle with a much lower price tag. This will not only reduce your debt service ratio, but it can also help you qualify for a mortgage.
Bottom Line
A car loan may be the only way to afford a vehicle purchase. But if you plan on purchasing a home in the near future, it’s important to consider how buying a car can affect your ability to get a mortgage. Before buying a car or a house, crunch the numbers to see how your income will be able to cover all your bills, including your car loan and mortgage payments. If you find that your debt load will be too much for your income to handle, consider a lower-priced vehicle and a cheaper home before making these big purchases.
