|Why auto loans and home loans do not mix
The next time you’re in the market for a car, do not plan on seeing a disclosure or a word of caution from the salesman about how buying that car with financing could adversely affect your chances for making a higher ticket purchase, such as a house.
Unfortunately, an auto loan will affect your ability to purchase a house no matter how big or small the payment. Lenders account for all liability payments the same. It’s not what you owe, but what you pay that counts.
Lenders account for all liabilities based on the minimum payment you’re obligated to make to your respective creditor.
You could have a car loan for $30,000, and the balance has no bearing on your ability to close on a house, but rather, the payment associated with that balance is a game changer. This is key, especially if you proactively prepay your auto loan in an effort to pay off the debt faster.
If you choose to pay more, that’s your prerogative, but for the purposes of qualifying for a mortgage, the minimum payments are king.
Leased or financed?
Say you have a car payment of $500 per month, you have two more years left on your lease that would be the same if you had a personal car loan for $500 per month with a longer-term obligation. The same reasoning applies, the minimum payment is what lenders will use to calculate how the liability will affect your ability to purchase a home.
It will impact your credit score
Having a clean auto loan payment history will do wonders for your credit score. It actually helps you qualify for a mortgage with a favorable credit rating.
Conversely, auto loan late payments can destroy a credit score.
Your credit score should be a bare minimum of 620 for mortgage eligibility these days.
Understand that if your credit scores lands in the 620 range, the lender is going to pay very close attention to your credit history as well as your capacity to handle a mortgage payment. They’re going to particularly keep a close eye on any pattern of payments related to any car loan you presently have or have had in the past, moreover, what the payment patterns reveal for showing good character.
How purchasing power is affected
Buying power is measured as the spread (difference) between income and liability payments. The bigger this gap, the bigger the mortgage payment could be, translating into buying ability.
In other words, if you have payment obligations and your income is four times the amount of the minimum monthly payments, that’s a healthy financial position to be in.
The logic is as follows:
For a ratio of 2 to 1, it’s every two dollars of income to offset one dollar of debt. For example, if you have a car loan payment at $400 per month, in order for that payment to not hurt your ability to buy a house, you need $800 in income to offset that debt.
In practicality, the next time you’re at the car dealership, and you’re taking on a $400 per month car payment and you know buying house is in your future, talk to your employer about that $9,600 a year raise or promotion you are eligible for. Why $9,600 in this example? Because $9,600 per year on a monthly basis is $800 per month, which is the minimum income needed to offset a $400 per month car payment.
Quick mathematical takeaways to use when house comparing:
• For every $100,000 in purchase price, that’s equivalent $725 per month on a total mortgage payment.
• For every .125 in rate on every $100,000 financed, the payment change by $7.25 per month.
• For $500 in mortgage payment that translates to upwards of $65,000 purchase price.
Buy house or car first?
In short, it depends on how far away you are from closing escrow on a house. If it’s a longer-term projection for getting your keys and your income is poised to rise, it may make sense to give credence to purchasing a house later on when financial stability is more grounded.
On the other hand, if you know you need to buy a car and buying a house is in the imminent future, buy the house first when the liabilities are lower. Because qualifying for car loan does not entail the extent of credit analysis a home purchase does, closing on a house first ahead of the car is a more makes sense move.
If the car purchase is a must and a home purchase is in the near future, first check with a lender to determine if you can qualify for the desired purchase price amount given your credit score, down payment capability, assets and debt ratio ( amount of current debt plus proposed mortgage payment plus monthly income). If qualifying for your desired purchase amount becomes cumbersome, things can become more tricky as you’ll need to pay off debt to qualify.
Paying off debt pitfalls
Would be buyers take heed, not all lenders allow you to pay off debt to qualify for a home loan. Some lenders might require you to pay off debt to qualify and subsequently close the account. Others simply won’t allow it wherein you would have to pay off the liability first in full, then authorize the lender pull a the credit report. Doing so, does not necessarily adversely affect your credit score so long as you’re not applying for different types of credit entities in around the same time you’re applying for a home loan. Lastly, if your pre-tax income is eroded by consumer debt like auto debts, even credit cards or personal loans, more significance is given to size of down payment, paying off the debt entirely, procuring more income or obtaining a co-signor.
Scott Sheldon is a local mortgage lender, with over six years of experience helping people purchase and refinance primary residences, second homes and investment properties. Visit him at www.sonomacountymortgages.com.