How Can Buying A Car Affect My Mortgage Approval Process?
Are you one of the many prospective home buyers out there searching for a new home? If so, great! There’s nothing quite like the feeling of finding that perfect place and beginning to plan the details of your move. That said, it is worth taking some time to consider how other areas in your finances can have an impact on this process – particularly when it comes to purchasing a vehicle.
Prospective homeowners should be aware that car loans can influence the likelihood of being approved for a mortgage. To understand how car loans can affect the whole process, it’s important to consider a few aspects regarding car loans: the size of the loan compared to your salary, the remaining payments, and whether or not you have been able to make steady monthly payments in the past.
In this post, we’ll go over how a car loan can potentially affect your mortgage approval process. Whether you’re just starting to search for homes or preparing for closing day, check out our insights below!
The Key Factors Of How A Car Loan Affects A Mortgage
Financing a vehicle purchase may negatively affect one’s ability to be approved for a mortgage loan both before and during the home loan process in several different ways:
Your Debt-To-Income Ratio
More on this below, but financing a vehicle purchase will normally have an impact on your debt-to-income ratio (DTI). This ratio is of great importance to mortgage lenders as they want to be confident you can afford their mortgage payments.
Your Credit Score
You will be opening a new credit account with your car loan, and this can lead to a dip in your credit score for two primary reasons. Firstly, the hard credit inquiry could reduce the score by several points. Secondly, the average age of all credit accounts may be lowered, which can impact the length of credit history and thus lower your score even further.
Your Cash Reserves
This is an important element when buying a home, as it’s vital to have sufficient funds for the down payment and to cover closing costs. For certain loan programs, extra cash reserves are also essential. Taking some of that money for a car loan deposit could have an impact on getting approved.
The Impact of Debt Service Ratio on Your Mortgage Application
It’s important to have a comprehensive understanding of your debt service ratio when it comes to applying for a mortgage. To increase the chances of a successful mortgage application, it’s advisable to maintain a debt service ratio below 36% for GDS and 44% for TDS. These percentages signify that the borrower’s debt payments should not surpass 36% of their gross monthly income or 44% to increase the likelihood of loan approval.
As such, it is important to consider the effect that taking out a car loan may have on your debt-to-income ratio before applying for a loan. If getting your new car pushes you out of the acceptable bracket, it will be much harder to get approved for a mortgage.
Here’s an example for you:
|No Car Loan
|Monthly Gross Income
|Car Loan Amount
With this example, you can see that your TDS score is well within the acceptable range prior to the car loan however, adding in that amount puts you over the 44% threshold.
Is it Wise to Buy a Car When Applying for a Mortgage?
When trying to get approved for a mortgage, it’s generally advised to avoid taking out any new credit in the six months to a year leading up to the application. But there are situations where one can’t wait to purchase a car so here are some scenarios that could make less of an impact:
- paying with cash – there won’t be a hit to your credit score because there’s no need to check your credit and you aren’t adding any more payments to your debt load.
- your TDS won’t change or will go down – this is applicable if you already have a car loan; if your new loan agreement/car payment will be at the same rate (or lower) as your current monthly payment, your TDS won’t be affected.
- possessing a high credit score above 720 – the higher your credit score, the more likely your account can take the hit caused by the credit inquiry.
The amount you can borrow for a mortgage is determined by the difference between your income and payments made toward existing debts. Generally, a higher spread between the two results in larger buying power and vice versa. An auto loan that takes up a large portion of your monthly income narrows the spread and reduces buying power, potentially hindering your ability to obtain a mortgage. Think carefully about all of your options and consult with a mortgage broker or loan officer before making any decisions.
Refinancing Your Current Car Loan
Refinancing an existing auto loan may be worth considering if it can help lower your DTI ratio. Even if your credit score dips slightly with the inquiry and new account, it may not make a significant difference, especially if your score is high enough. Reducing TDS can also be done by paying down your auto loan so there are only ten or fewer payments left on the account. Why? Because at this point, mortgage lenders can exclude the payment from any calculations. You could also pay off your car completely, as long as there isn’t a prepayment penalty and it won’t affect your cash reserves too much!
How the Length and Amount of Financing Affects Your Mortgage Application
When considering a mortgage application, lenders are likely to take into account many factors, including the length and amount of any existing car loans. If a borrower has an outstanding auto loan of large amounts spread over a longer term, it’s likely to affect their ability to get approved for a mortgage. This is because they’re viewed as having more financial obligations that must be met each month; thus reducing their capacity to make payments on another loan.
On the other hand, if a borrower has completed their car loan payments or opted for smaller increments over shorter loan periods, they may be viewed as being more suitable candidates for mortgages by prospective lenders. It’s important to check your credit score before applying for a mortgage so you can make sure there will be no surprise issues that may affect your eligibility.
What to Do if You Have Multiple Outstanding Loans
If you’re in the process of applying for a mortgage and have multiple outstanding loans, it’s important to take the right steps to prepare. One way to improve your chances of being approved is to pay down as much of your outstanding debt as possible. Even if you’re unable to pay it off completely, paying down a significant amount can show potential lenders that you have good credit management habits.
In addition, make sure you have an up-to-date budget plan which shows how much money is coming in each month, along with a clear repayment strategy for your outstanding loans. Having this information readily available will be beneficial when it comes time to apply for a mortgage – and may help increase the likelihood that your mortgage application is accepted.
With the right information, you can certainly make your mortgage pre-approval process easier by understanding how a car loan may affect your chances of being approved. Taking our advice into consideration will also help you keep the debt-to-income ratio low and lower the amount of interest you’re paying while ensuring that all financing costs can be covered in the event of an emergency.
Understanding the impact of multiple outstanding loans is also essential to a successful approval. Ultimately, taking the time to evaluate your current situation and determine any areas that need improvement, can give you an idea of what you should do when applying for a mortgage. With all this in mind, take care to ensure that any potential car loan won’t interfere with your plans to finance a home.
About the Author:
At Sterling Homes, our mission is to provide the opportunity for affordable homeownership without compromise. Over the last 70 years, Sterling Edmonton has quickly become one of Edmonton’s most popular builders. We bring more than seven decades worth of exceptional customer service, superior design and unparalleled craftsmanship to the greater Edmonton area. As a member of the Qualico Group, Sterling Homes focuses on greater Edmonton’s finest family communities, while being able to offer some of the region’s most family friendly prices thanks to volume purchasing power for materials, trades and land. This has not only made Sterling one of Edmonton’s bestselling, move-up builders, but also one of the industry’s most respected home providers. It is through our uncompromising commitment to our customers that we proudly deliver the Sterling Advantage – that’s why each and every home we build includes a 10-year home warranty, a completion guarantee and new home warranty excellence rating. Our Advantage is our pledge that, when you build your dream home with Sterling, we will deliver a timely, well-built home you’re sure to enjoy for years to come.
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