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Cars and houses are two basic needs that, when bought back-to-back, might result in negative consequences.
If you've been considering buying a house, it's important to do your research and know how the home-buying process works. Buying a house is one of the biggest purchases you’ll make in your lifetime. Lenders know this. That's why they take every detail into consideration before making the commitment to fund your home. They want to know beyond a shadow of a doubt that you can keep up with the expenses associated with home ownership. As lenders go through your financial history, it's not uncommon for past financial choices to come back to bite you, and possibly even prevent you from qualifying for a home loan.
It's for this very reason that purchasing a car before buying a home is a big no-no. Whether you’re looking to buy a 2020 Tesla Model S or a 2003 Chevy Silverado, an auto loan will affect your ability to purchase a house no matter what the amount.
Here’s why.
It affects your debt-to-income ratio
Your debt-to-income ratio, or DTI, plays a large role when qualifying for a mortgage because it more or less determines your buying power in the eyes of lenders.
Lenders calculate your DTI by measuring the difference between your income and your liability payments. “Liability” is a fancy word for debt you’re currently paying off, such as student loans, auto loans, mortgages, secured and unsecured personal loans. The larger the gap is between your income and these liabilities, the more trustworthy you’ll appear to lenders.
But here's an interesting note. If you're a first time homebuyer, there are special loan programs that let you put down less money upfront. This could be a great option if you're still saving or if you're paying for other big expenses, like a car. It doesn't change your monthly mortgage payments, but it might make buying a home more realistic for you.
To be clear, liabilities are not bad. But they do reveal a lot about your relationship with money. You should always aim to have the lowest DTI possible — not just to qualify for the home you want — but to also ensure that you’re able to live comfortably while paying off your debts. The Federal Housing Administration generally uses the 43% DTI ratio standard as a guideline for approving mortgages. It varies, though. You'll find that some lenders are more flexible while others are more rigid, depending on the real estate market and economic conditions.
When considering your qualifications, lenders may not include installment debts like auto or student loans as part of your DTI if you’re close to paying them off. But multiple big-ticket debts, like cars and homes, can signal to lenders that you’re in danger of overextending your finances — because not only are you looking to borrow a large sum of money for a new home, but you are also adding a car loan to your monthly spending for the next three-to-six years. So, if you’re paying $450 per month on a new vehicle, lenders will use that payment to calculate how the liability will affect your ability to purchase a home. It may appear that, after committing to an auto loan, you have less funds available to afford a house. Even if that’s not the case, it is something lenders have to take into consideration.
It can lower your credit score
You’ll want to make sure your credit is in tip-top shape before you start the home buying process. Purchasing a new vehicle can negatively affect your credit score because your score will have to absorb both a hard inquiry and a new account, both of which will ding your score by five points or so. The truth is, car loans in good standing can boost your credit score over time. But when you first make the purchase, since there is no payment history associated with the loan yet, you’ll likely see a drop in your score. That’s why if you're looking to purchase a new home soon, you should hold off on buying a vehicle as it could temporarily hurt your credit score.
To get your home buying journey started on the right foot, we recommend you first visit www.annualcreditreport.com and review copies of your credit report from the three major credit bureaus (Equifax, Experian, and TransUnion) at least 90 days before you plan to apply for a mortgage.
Here are some proactive ways to keep your credit score in good condition:
- Pay your bills on time, every time.
- Avoid transferring balances to new credit cards.
- Keep your credit cards open and use them regularly. The longer you use them, the better.
- Pay down your debt and keep a low balance on your credit cards.
When is the right time to purchase a vehicle?
If you’re in desperate need of a new car, you may have to bite the bullet and just deal with the consequences. If it’s possible to pay cash for the vehicle, then by all means, do that.
At the end of the day, the best approach is to wait until you have keys to your new house before buying a car.
Fair warning, though. You may feel tempted to head over to the dealership as soon as you have your mortgage approval documents in hand. That’s not the time to start borrowing again.
Why? Because many lenders audit your file in the days leading up to closing. If your score drops during that time, your mortgage rate could increase. Or even worse, your lender could withdraw the offer completely. Hold off on new borrowing until the check clears, and not a minute sooner.
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