Should I get a new car loan with a lower monthly payment to improve my debt-to-income ratio before I apply for a mortgage?
In general, lowering your monthly debt payments to improve your debt-to-income ratio before you apply for a mortgage is a good idea. There are a couple of points to keep in mind, however, so that your new car loan does not negatively impact your ability to qualify for the mortgage.
Reducing your monthly car loan payment should enable you to qualify for a larger mortgage because you can afford to spend more money on your mortgage payment and other housing expenses such as property tax and homeowners insurance. In short, the lower your monthly debt payments for items such as credit cards and car, personal and student loans, the higher the mortgage amount you can afford.
Use ourMORTGAGE DEBT-TO-INCOME RATIO CALCULATORto determine the loan you can afford
The example below shows how reducing your car loan payment increases the mortgage you qualify for. In the first case, the applicant has a $500 car loan payment and can afford a $283,000 mortgage as compared to the second case when the applicant has a lower $250 car loan payment and can afford a higher $325,000 mortgage. This example assumes a 30 year fixed rate mortgage with a 4.000% rate.
Case 1: $500 Car Loan Payment
Monthly Gross Income: $5,000
Car Loan Payment: $500
Other Monthly Debt Payments: $300
Mortgage the Applicant Qualifies For: $283,000
Case 2: $250 Car Loan Payment
Monthly Gross Income: $5,000
Car Loan Payment: $250
Other Monthly Debt Payments: $300
Mortgage the Applicant Qualifies For: $325,000
The example above demonstrates the benefits of reducing your car loan payment before you apply for a mortgage. The actual benefit you derive and mortgage you qualify for depends on many factors including your monthly gross income, interest rate, mortgage program and how much you lower your loan payment.
While lowering your car loan payment can help you qualify for a mortgage, we recommend waiting one-to-two months after your new car loan closes before you apply for the mortgage. This is because you want to make sure that your new, lower car loan payment is reflected on your credit report and mortgage application.
Additionally, applying for a car loan can cause your credit score to go down, at least temporarily. Depending on how much your score drops, you may be required to pay a higher mortgage rate. If you can wait a couple of months before you apply for the mortgage, your credit score has more time to recover and possibly increase, which may enable you to qualify for better mortgage terms.
We should also emphasize that you should not apply for a new car loan – or any new loan for that matter – after you submit your mortgage application. In addition to checking your credit report at the beginning of the mortgage process, most lenders check your score approximately one week before your mortgage is scheduled to close to make sure there has been no significant change.
If your credit score falls because you applied for a new car loan, it may delay or prevent your mortgage from closing or you may be required to pay a higher interest rate. This could increase your monthly payment and cost you thousands of dollars in extra interest expense over the life of your mortgage, which negates the benefit of lowering your car loan payment.
In closing, we recommend reducing your monthly loan payments and improving your debt-to-income ratio before you apply for mortgage. The more time in between when you lower your loan payments and submit your mortgage application, the better.
The table below shows mortgage rates and fees for top-rated lenders in your area. We recommend that you contact multiple lenders to understand the mortgage you qualify for and to find the best loan terms.
View All Lenders%
Sources
"B3-6-02, Debt-to-Income Ratios." Selling Guide: Fannie Mae Single Family. Fannie Mae, February 5 2020. Web.
« Return to Q&A Home About the author