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Financing a vehicle during the mortgage approval process can have major consequences if you're not careful. Not only could it affect your debt-to-income ratio, but it could also have an impact on your credit score and your cash reserves.
Here's what to know about how a car loan could affect your mortgage approval and some options you may have if you can't wait.
How Does a Car Loan Affect a Mortgage?
There are a few different ways financing a vehicle purchase can have a negative impact on your approval odds for a mortgage loan, both before and during the mortgage process:
- It may increase your debt-to-income ratio. Your debt-to-income ratio (DTI), or the percentage of your gross monthly income that goes toward debt payments, is a crucial factor for mortgage lenders because they want to ensure that you can afford to make your payments. It's generally best to have a DTI below 43%, and if a new car loan pushes you beyond that amount, it could be more difficult to get approved.
- It could affect your credit score. When you open a new credit account, it can cause a temporary dip in your credit score for two reasons. First, the hard credit inquiry can knock a few points off your credit score. Second, opening a new credit account reduces the average age of all of your credit accounts, which can negatively affect your length of credit history.
- It may reduce your cash reserves. When you're buying a home, it's important to have enough cash set aside for a down payment and to pay closing costs. With some loan programs, you may also need additional cash reserves on top of that. If you take some of that money and put it toward a down payment on a car loan, it could affect your approval.
Can You Buy a Car and Still Get Approved for a Mortgage?
In most cases, it's best to avoid taking out new credit while you're trying to get approved for a mortgage loan. In fact, some mortgage and credit experts recommend avoiding new credit during the six months to a year leading up to your mortgage application, just to be safe.
That said, if your circumstances make it so that you can't wait to buy a car, here are some scenarios where it might make less of an impact:
- You pay with cash. You have enough cash to buy a car outright without compromising your mortgage down payment and closing costs, as well as applicable cash reserve requirements from your lender.
- Your DTI won't change or will go down. Your new auto loan has a similar or even lower monthly payment than your current one.
- Your credit score is high. Your credit score is in the upper 700s or even 800s and can absorb any minor, temporary damage caused by the hard inquiry and new account.
In any situation, think carefully about your options and how the proposed auto loan can impact you. You may also want to consult with a mortgage broker or your loan officer to understand how lenders will view your decision.
Could Refinancing an Auto Loan Affect Mortgage Approval?
Refinancing your existing car loan can be worth considering if it can help reduce your DTI. Even if your credit score dips slightly with the inquiry and new account, it may not be an issue if your score is high enough to absorb it.
Another way to reduce your DTI is to pay down your auto loan or a different installment loan enough that you only have 10 or fewer payments left on the account. Once a loan gets to that point, mortgage lenders can exclude the payment from your DTI calculation.
You can also postpone other large purchases to keep your credit card balances down and make other efforts to pay down small balances to eliminate the monthly payment.
Make Your Credit a Top Priority in the Mortgage Process
A mortgage is a major financial commitment, both for you and the lender. As a result, it's best to keep your credit file in tip-top condition leading up to and during the mortgage approval process.
Experian's free credit monitoring service can help you by giving you access to your Experian credit report and your credit score powered by Experian data. Using the information, you can address potential issues that may affect your mortgage approval and also keep track of your progress.
If your credit score isn't where you want it to be, consider taking the time to improve your credit before you apply for a mortgage. This may delay important decisions, but it can help you save thousands or even tens of thousands of dollars in the long run.