Q: We expect to be buying our first home in the next couple of months. Would purchasing a new car in the next couple of months as well affect our ability to qualify for a home loan from a bank?
A: Great question. I’m glad you asked it now, rather than after you had signed a loan for your new car!
When a mortgage lender calculates how much you can afford to spend on a home, the lender looks at the total amount of debt, as well as what part of your income is available to service that debt each month.
Traditional lenders will allow you to spend up to 28 percent of your gross monthly income on your mortgage, taxes and insurance and up to 36 percent on your total debt, including school loans, auto loans, credit card debt and any other type of personal loans. The more debt you have, the less income you can put toward the mortgage, taxes and insurance. For example, if you don’t have any sort of debt, lenders will allow you to spend the entire 36 percent on your mortgage, property taxes and insurance.
(If you get an FHA loan, you may be able to spend more than 40 percent of your gross monthly income on all of your debts. But that will translate into you spending more than half your take-home pay on your mortgage, taxes, insurance, and debts.)
When you apply for the loan, lenders will pull a copy of your credit history, which lists all of your loans, your creditors, and your payment history. A new car loan will be part of that picture, and it could alter your debt-to-income ratio just enough to make your home loan unaffordable (according to your lender).
What you want to do is make sure nothing significant changes in your financial life from the date you put in your loan application until the date you close on the home. That means putting off any major expenses or purchases.
The lender will often pull a second credit report just to make sure your credit history hasn’t changed, which is why if you’re going to make a big purchase (like a car), you’re best off waiting until after you’ve closed on your house. At that point, you’re free to spend whatever you can afford, and not worry about how your debt-to-income ratios or amount of cash you have on hand will be affected.
One thing: If you do plan to buy a car, be sure you calculate (just for yourself) how much it will cost per month and whether that’s affordable. You don’t want to buy a new car and have it tip your finances over the edge after you’ve just closed on your first home.
Finally, if you buy the car for cash and still have sufficient money saved up for the purchase of the home, you might not have to worry about the timing of your new car purchase. Just keep in mind that most lenders today will offer lower interest rates, better loan terms and a faster application approval to those buyers who have more cash available for a down payment and reserves.