Having a car is definitely a priority for the average person and is more often than not their first big purchase in life. But did you know that your monthly car payments could prevent you from getting the mortgage you need to buy the home of your dreams?
Having a car loan that takes up too much of your monthly income can negatively impact your chances of being approved for a mortgage. Here’s everything you need to know about how a car loan can affect your ability to buy a house.
Can Buying A Car Affect Your Ability To Buy A House?
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.
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.
One of the factors that mortgage lenders look at when determining whether or not to approve a mortgage application is overall debt, especially as it relates to income. 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 be comfortable knowing that you’ll be able to make your mortgage payments on time every billing cycle and that you won’t default on the loan. Here are some of the factors that lenders consider when approving you for a mortgage and how a car loan can impact it.
Debt-To-Income (DTI) Ratio
Your debt-to-income (DTI) ratio refers to how much of your gross monthly income is dedicated to paying your monthly debt 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 DTI of no more than 35%.
How Your Car Loan Affects Your DTI Ratio And Your Mortgage Affordability?
Adding a car loan to your debt load will reduce your overall mortgage affordability. Unless you start earning more in the near future, a car payment will cut into your earnings and leave less left over for other loan payments, including a mortgage.
If your finances are strong, a car loan itself shouldn’t 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. Your DTI will help lenders assess your financial strength and the risk they will assume by extending a mortgage to you.
Total Debt Service (TDS) Ratio
Your total debt service (TDS) ratio refers to all your debt payments in addition to your housing costs relative to your income and is represented as a percentage. 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.
By adding a car loan to your debt, you’ll be increasing your TDS ratio, 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.
How To Calculate Your TDS Ratio?
To calculate your TDS ratio, take the sum of your monthly debt payments, and add in your monthly housing costs. Take that figure and divide it by your monthly gross income and multiply by 100. The answer you get is your TDS ratio represented as a percentage.
When you throw in a car loan payment into your monthly debt obligations, you’ll be increasing your debt in relation to your income, which could increase your TDS ratio.
The following chart illustrates how a car payment can impact your TDS ratio:
Car Loan | No Car Loan | |
Total Debt | $1,500 | $1,500 |
Car Loan | $500 | $0 |
Total Debt | $2,000 | $1,500 |
Monthly Gross Income | $4,000 | $4,000 |
TDS Ratio | 50% | 37.5% |
As you can see, your TDS would come under the threshold of 44% without the car loan payment in this exampe. In this case, you’d have a good chance of getting approved for a mortgage at a relatively competitive interest rate, as long as all other factors are acceptable.
But if you add a car loan into the equation, it puts you over the edge at a 50%. In this case, you may have a more difficult time getting approved for a mortgage, since your lender may consider you a higher risk.
How Your Car Loan Can Affect Your Credit Scores And Mortgage Approval
Your credit score has a direct effect on your ability to secure a mortgage. Ideally, your credit score should be at least 660-680 or higher to minimize the lender’s risk and thereby improve your chances of getting approved for a mortgage.
When you apply and take out a car loan, your credit may be affected,which in turn can affect your ability to get approved for a mortgage and the interest rate you can get. Here are some ways your car loan can affect your credit:
- Credit Check – For starters, your lender will conduct a “hard inquiry” of your credit report, which will temporarily cause your score to dip.
- Payment History – Further, your car loan payments can impact your credit score negatively if you don’t keep up with your regular payments.
If your credit score is very high, there’s likely nothing to be concerned about. But if your score is already on the lower end, applying for a car loan could mean the difference between approval or rejection of your mortgage application.
Buying A Car And House FAQs
Does buying a car affect my purchasing power?
Will a car loan lower my credit scores?
What credit score do I need to get a mortgage?
How do I calculate my DTI ratio?
Bottom Line
Cars are an absolute necessity for some people, however, if you plan on purchasing a home in the near future, it’s important to consider how your car purchase can affect your home purchase. Buying a car can affect your ability to buy a house but it doesn’t have to prevent you from getting the home of your dreams.
If you plan on paying off your car loan before purchasing a home, then there’s no issue. However, if you plan on buying a home while paying off your car loan, it’s important to buy a reasonably priced car, one that you can afford to make payments on now and in the future if when you buy a house.