Buying a car before buying a house is rarely ever advisable. Considering how expensive a house is, it's better to purchase your home first so that you can qualify for the best loan terms.
If you’re in the market for a house and car, figuring out which to buy first can be tough. While you may need both, buying a car before buying a house is generally a bad idea. This is because your auto purchase can decrease your credit score and available down payment while increasing your debt-to-income ratio.
To help you avoid the common pitfalls of a house vs. car purchase, this article will examine how purchasing a car impacts your home-buying ability and what alternative options may be available.
Should You Buy a Car Before Buying a House?
Yes, you can buy a car before you purchase a house, even if you are in the middle of the home-buying process. But just because you can, doesn’t mean you should.
Getting mortgage approval can be difficult. You need a decent credit score, a sizable down payment, a good DTI ratio, and more. By purchasing a car right before you attempt to buy a house, you can decrease your credit score and rob the savings you have available for a down payment. This will make the already difficult approval process even harder.
A car loan that has already been on your credit for a few years is different. If you’re wondering, should I pay off my car loan before buying a house, the short answer is yes. It can improve your DTI, and if your car loan interest rate is high, paying off the loan now can save you money. Just don’t compromise the down payment on your house.
When To Buy a Car First
Often, it's better to wait to buy a car until after your home purchase is complete. However, there are situations where buying a car before buying a house might be the smart choice.
- Your DTI is low - For instance, if your income is $100,000 and your current DTI ratio is 5%, adding a $500 car payment will bring it up to 11%, which is still well within the ideal territory.
- You’re in the early planning stage - Let’s say you’re making a 5-year plan to save money and search for a home. If you purchase a vehicle now, the loan may actually help your credit, and you could be done making payments by the time you’re ready to apply for a mortgage.
- You need a car - Sometimes, buying a car is unavoidable. If you need a vehicle to commute to work, taking out a car loan is more than worth it, even if it hurts your mortgage readiness.
Four Ways Buying a Car Impacts Your Home-Buying Ability
Purchasing a car right before attempting to qualify for a home loan may not be the best move. Here are four ways this can impact your home-buying ability.
1. Temporarily Decreases Credit Score
Taking out a new car loan may initially decrease your credit score. This is thanks to the impact of the hard inquiry (for loan approval) and the ding to your average age of account.
The upside is that this impact is temporary, and your new car loan may actually improve your credit score over time.
2. Debt-to-Income Ratio (DTI) Could Increase
When applying for a mortgage, the bank will measure your income against your outstanding debts to determine your debt-to-income (DTI) ratio. By taking on a new auto loan, you’ll increase the amount of debt you have. This will increase your DTI ratio.
The higher your debt-to-income ratio is, the riskier it is to lend money to you. An ideal DTI ratio is generally 36% or less, with 50% or more being extremely risky.
Let’s say your income is $65,000 and your DTI ratio is currently 33%. Taking on a $500 car payment would raise your DTI ratio up to 42%, while a $950 monthly payment would take you over 50%.
With your debt-to-income ratio central to the loan approval process, doing anything to increase it, like buying a car, can disqualify you for a home loan.
3. New Debts May Impact Mortgage Readiness Rating
Before approving a home loan, your lender will rate your readiness for a mortgage. To do this, they’ll look at your income, your debt-to-income ratio, your credit, how much you have in savings, your potential down payment, and more.
If you recently purchased a vehicle, this will be a red flag to the lender and will hurt your mortgage readiness rating. If you are in the process of buying a home and you take on a new auto loan, this dip to your mortgage readiness may result in your mortgage approval falling through.
4. Risk Cutting Down Your Home Down Payment
You may have needed to put down a sizable down payment to get the best terms on your auto loan. But doing so might leave you scrambling for cash to apply towards your home loan.
When applying for a mortgage, you’ll need to provide a down payment that meets the minimum for the type of loan you are taking out (i.e., FHA versus conventional). This minimum doesn’t include other common costs of purchasing a home, like closing costs or buying mortgage points. Not having sufficient funds will crater your loan approval.
Reducing your down payment often means your loan approval amount will decrease.
How To Minimize Negative Impacts If You Have To Buy A Car First
If you are forced to take on an auto loan before or during the mortgage process, here are some tips to help you minimize the negative impacts:
- Postpone your mortgage application - This gives your credit a chance to rebound from the negative effects of opening a car loan and gives you a chance to replenish your savings.
- Pay the loan on time and use it to improve your credit score - As your auto loan ages, your positive payment history can help you build/rebuild credit, which may help in getting a mortgage approval.
- Put up a larger downpayment to reduce the loan amount - You can offset the hit your credit may take by offering to put up a larger down payment on your home loan. This gives you more equity, reduces the bank's risk, and can decrease your overall mortgage payment.
- Look for a cheap vehicle - The less debt you take on right before applying for a mortgage the better. Try to find a cheaper car and put as much of a downpayment up as possible. You can always trade the vehicle in later after you buy your home.
- Get prequalified for a loan to avoid unnecessary hard inquiries - each hard inquiry, or hard pull of your credit, has the potential to harm your score. By getting prequalified for both your car loan and home loan, you can reduce these hits to your credit.
You can also consider transportation alternatives like carpooling or public transport, which allows you to put off your auto purchase until after your home purchase is complete.
Alternative Solutions to Buying a Car Before a House
Buying isn’t your only option when it comes to securing transportation. Here are some alternatives that can get you where you need to go without impacting your mortgage readiness.
- Lease a vehicle
- Use public transportation
- Carpool with coworkers
- Borrow a friend or family member’s car
- Utilize ride-share services
- Rent a car
- Looking into delivery services for groceries
- Take up biking or walking
If you are already in the process of obtaining a mortgage, these options can help you postpone a car purchase for a few weeks until after you close on your house.
Ready To Improve Your Credit Score?
Buying a car before buying a house can hurt your chances of getting approved for a mortgage. An increase in your DTI ratio and the hit to your credit will make you a less attractive borrower. Once the car is purchased, the only real actions you can take are to save up for a bigger down payment and work towards achieving a good credit score.
The Credit.com mortgage rates page can give you an idea of what home loan terms you might qualify for with your current credit rating. If you don’t know what your credit score is, it’s time to check. With a free credit report card from Credit.com, you’ll get detailed insight into your credit and actionable tips for improving your score.
FAQ
Should I Pay Off My Car Before Buying a House?
If you’re close to having your vehicle paid off or your car loan interest rate is high, then yes, paying it off before you buy a house will help your DTI ratio. However, if paying off the balance will eat into the money you have set aside to put up a down payment or cover closing costs, then it's better to postpone paying off your car loan.
How Long Should I Wait After Buying a Car to Buy a House?
Before buying a house, ideally, you want to wait at least 6 months from the date you purchased your car. The longer you wait, the better.
Why Can it Be Beneficial to Increase Your Credit Score Before Buying a House?
Improving your credit score can increase your chances of mortgage approval and help you qualify for the best interest rate (APR). The better your APR, the less you’ll pay over the life of the loan. With a mortgage, this can result in saving tens of thousands long-term.
