The NFCC often receives questions from readers about their money challenges. We answer your common questions in our Ask an Expert series, in hopes of helping readers find the information they need.
This week’s question:
My wife and I are looking to get our first home this year. Unfortunately, my car started acting up and now I need to look at getting a car. If I get a loan for a car, will it affect my ability to buy a house?
Answer:
Buying a car is one of the most important purchases you’ll make in your life, though buying a home is even more important. Your ability to get both (whether in the same year or not) will depend on a few details, including your income, credit rating and debt.
Because buying a home is a much bigger financial commitment, you’ll want to make that your priority. That means, if possible, putting off a car purchase until after you’ve closed on your home. Why? Because financing a car can cause your credit scores to drop, increase your debt-to-income (DTI), and eat away at your down payment for a house, all of which make it harder to qualify for an affordable mortgage.
That doesn’t mean you can’t get a mortgage after you buy a car, but it can make homebuying more costly.
How a car loan affects your credit
Taking on a new loan can affect your credit in a few ways. The initial impact will likely be negative, but it can be positive in the long run. Here’s what happens:
Hard inquiries
Every loan you apply for results in a hard inquiry on your credit reports, which can lower your credit scores by anywhere from zero to around five points. You can limit this damage by applying for car loans during a 2-week “rate-shopping” period, in which multiple inquiries only count as one.
Higher credit utilization
Taking on a new loan increases your credit utilization ratio (how much debt you owe in comparison to your available credit), which lowers your scores. The number of points you lose will vary based on a few factors, including the size of the loan and other details in your credit reports.
Build positive history
On the bright side, your score can bounce back if you make your monthly car loan payment as agreed. With time, you can also gain points by reducing your loan balance and by using a mix of different products (credit cards and loans) responsibly.
How a car loan affects your ability to get a mortgage
In addition to reducing your credit scores, taking on a new auto loan can harm your chances of getting approved for an affordable loan in the following ways:
Debt-to-income ratio (DTI)
Having a new loan increases your debt-to-income ratio since you now have more debt with the same income. The lower your DTI the better, but each lender has their own limit. For conventional loans there’s usually a requirement of 43% or lower.
To calculate your DTI, add up your monthly required debt payments, divide them by your gross monthly income and then multiply by 100.
Down payment
When you buy a car, your spare cash may end up going toward the down payment on the car and away from your down payment on the home.
However, some people may have enough money both. Twenty percent is often the recommended amount for a home, since putting down 20% can alleviate you from having to pay Private Mortgage Insurance (PMI). However some loans, such as VA home loans, have a lower requirement.
Proceed with caution
If you have excellent credit and enough purchasing power to meet the lender’s criteria, you shouldn’t have a problem buying a car and then a home. But you may want to wait at least six months between purchases so your scores have enough time to increase. By doing so, you could qualify for lower interest rates and save a significant amount of money.
Alternatively, you might consider using cash to buy a reliable second-hand car, or working to increase your income and pay down debt before you start applying for loans. The bottom line is that buying a new home is a huge commitment that extends far beyond just qualifying for a mortgage. It’s a loan you’ll likely be paying back for 30 years. So before applying, review your budget, set your priorities, and consider scheduling a homebuyer counseling session with an NFCC certified financial counselor who can help you get mortgage ready