Is It Bad to Buy a Car Before a House?

Buying a car and purchasing a home are significant financial undertakings. The timing of these major purchases can profoundly influence mortgage eligibility and terms. This article explores the financial aspects to consider when deciding whether to buy a car before a house.

Credit Profile Implications

Acquiring a car loan alters an individual’s credit profile, which lenders scrutinize when evaluating mortgage applications. When applying for a car loan, a “hard inquiry” is typically made on your credit report, which can cause a small, temporary dip in your credit score, usually less than five points. Multiple hard inquiries within a short period could potentially signal increased risk to lenders, though inquiries for rate shopping on auto or mortgage loans within a 14-to-45-day window are often treated as a single inquiry for scoring purposes.

A new car loan also introduces a new installment account to your credit history. This new debt can temporarily reduce the average age of your credit accounts, which is a factor in credit scoring models. However, consistently making timely payments on the car loan can ultimately benefit your credit history by demonstrating responsible debt management.

Payment history is a substantial component of credit scores, and positive performance on an installment loan, like a car loan, can contribute to building a stronger credit profile over time. Mortgage lenders prefer to see a stable credit history with established accounts and a demonstrated ability to manage various types of credit. A recently opened car loan, especially one with a substantial balance, might be viewed with caution as it represents a new financial obligation. Its immediate impact, particularly if opened close to a mortgage application, is important to consider.

Debt-to-Income Ratio Considerations

The debt-to-income (DTI) ratio is a percentage that mortgage lenders use to assess a borrower’s ability to manage monthly payments and repay a loan. This ratio compares your total monthly debt payments to your gross monthly income. A new car payment directly increases your total monthly debt obligations, consequently raising your DTI ratio.

Most mortgage lenders prefer a DTI ratio of no more than 36%, though some may approve loans with a DTI up to 43%. Certain government-backed loans, such as FHA loans, might allow for slightly higher DTI ratios, sometimes up to 50% under specific circumstances.

Exceeding these DTI thresholds due to a new car loan can have several consequences for a prospective homebuyer. A high DTI might reduce the maximum mortgage amount for which an individual qualifies, as lenders will determine how much additional debt can be comfortably afforded. In some cases, a significantly increased DTI could even lead to the denial of a mortgage application, as it signals a higher risk of financial strain.

Impact on Available Savings

Purchasing a car can substantially deplete or divert the financial resources that would otherwise be available for a home purchase. A car down payment requires a direct outlay of liquid savings, with experts often suggesting a down payment of at least 20% of the car’s purchase price to secure better loan terms. This immediate expenditure reduces the funds available for a mortgage down payment, which is a significant component of buying a house.

Beyond the down payment, homebuyers face substantial closing costs, which typically range from 2% to 6% of the loan amount. For example, on a $300,000 home loan, closing costs could range from $6,000 to $18,000, in addition to the down payment. These costs include various fees such as appraisal fees, title insurance, and loan origination fees, and they must be paid upfront at the time of closing.

Draining savings for a car purchase can make it challenging to cover these substantial closing costs, potentially forcing a delay in the home purchase or requiring a smaller down payment. A smaller down payment might lead to higher monthly mortgage payments or additional costs like private mortgage insurance.

Maintaining an adequate emergency fund is also important for unexpected homeownership expenses, which can arise from unforeseen repairs or maintenance. A car purchase that significantly diminishes savings could compromise this financial safety net, leaving a homeowner vulnerable to financial distress if unexpected home-related costs or changes in income occur.

Lender Underwriting of Recent Major Purchases

The mortgage underwriting process involves a thorough evaluation of a borrower’s financial situation to determine the risk associated with lending money. Underwriters meticulously review credit reports, income, assets, and debts to ensure a borrower can meet their mortgage obligations. A newly acquired car loan, especially if taken out shortly before or during the mortgage application process, is identified as an increased financial obligation.

Lenders analyze the interplay between a borrower’s loan-to-value (LTV) ratio and their debt-to-income (DTI) ratio. While LTV relates to the amount borrowed compared to the home’s value, new debt primarily impacts DTI. A new car loan can alter this assessment by increasing the borrower’s total monthly debt, potentially pushing their DTI beyond acceptable limits.

Underwriters view such new debt as a change in financial stability, which can lead to a re-evaluation of the mortgage approval. It is important to communicate transparently with mortgage lenders about any new financial obligations incurred.

Lenders often conduct a final credit check just before closing to verify that the borrower’s financial situation has not materially changed since the initial application. Taking on significant new debt, like a car loan, during this period can trigger concerns for the underwriter, potentially delaying the closing or even leading to the denial of the mortgage.