Does applying for a car loan affect your ability to qualify for a mortgage?

By Michael Jensen, Mortgage and Finance Guru

Edited by Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience

Updated October 20, 2020

In short, applying for a car loan can negatively affect your ability to qualify for a mortgage. If possible, I recommend that you wait until your mortgage closes before your apply for a new car loan. As we explain below, taking out a car loan -- or any loan for that matter -- can make it more challenging to get approved for a mortgage for multiple reasons.

First, a new car loan potentially increases your monthly debt payments which hurts your debt-to-income ratio. Simply put, your debt-to-income ratio is the ratio of your total monthly debt expense -- including your mortgage, property tax and homeowners insurance plus payments for other debts such as credit cards and car, student and personal loans -- to your gross income.

Lenders only permit you to spend so much of your income on monthly debt payments and usually apply a maximum debt-to-income ratio of 40% to 50% to determine the mortgage you can afford.  The more money you spend on non-housing related debt, such as a car loan, the less money you can afford to spend on your mortgage and the lower the mortgage you qualify for.

For example, if you take out a new car loan with a monthly payment of $450 and you previously had no payment or a lower payment, then the mortgage you can afford may be reduced significantly, depending on your income.  If your new car loan payment is lower, then your debt-to-income ratio improves and the mortgage you qualify for may increase.

Use our MORTGAGE QUALIFICATION CALCULATOR to determine the loan you can afford based on your monthly income and debt expense

Applying for a car loan can also impact your credit score, which affects your ability to qualify for a mortgage. When you apply for the loan, lenders pull your full credit report which can can cause your score to drop, at least temporarily. 

Lenders use your credit score to set your mortgage terms and to determine your eligibility for certain loan programs.  Depending on the program, applicants with a lower credit score may be required to pay a higher mortgage rate. The higher your rate, the lower the mortgage amount you can afford. Paying a higher mortgage rate also increases your monthly payment and interest cost.

The table below shows mortgage rates and closing costs for top-rated lenders near you.  We recommend that you contact multiple lenders to confirm their qualification guidelines and to find the best loan terms.

While a lender credit inquiry for a car loan should not impact your credit score too significantly, you want your score to be as high as possible when you apply for a mortgage.  Additionally, if you decide to move forward with the car loan, as long as you make your payments on time your credit score should recover and potentially increase, but that process can take several months.

To summarize, if  feasible, we recommend that you hold off on taking out any new loans or increasing your debt balance until after your mortgage closes.  This approach should help you maintain your debt-to-income ratio and maximize the mortgage you can afford.

If you cannot wait to apply for a new car loan then I recommend that you take out the loan with the lowest possible monthly payment and always make your payments on time. Taking these steps puts you in the best position to qualify for a mortgage.

Sources

“What is a debt-to-income ratio? Why is the 43% debt-to-income ratio important?”  CFPB.  Consumer Financial Protection Bureau, November 15 2019.  Web.