After buying a home, a car is probably the largest purchase you will ever make. However, if you are going through the process of applying for a mortgage and closing on a home, you may want to reconsider buying a new car until after the deal is finalized. If you feel that you must purchase a car before closing day, check with your mortgage broker or loan officer for advice first since you could be risking your home loan.
TL;DR (Too Long; Didn't Read)
If you take out a loan for your new car, this new debt affects your debt-to-income ratio and shows up on your credit report, which can negatively impact your mortgage approval.
Changes on Your Credit Report
Every time you apply for a loan, pay a credit card bill or do anything that involves credit, the information is documented on your credit report. Lenders then look at these reports to determine if they should grant you new loans. Applying for either too much debt or for too many loans at the same time will appear as a negative to lenders when they consider you for a new loan.
Impact on Debt-to-Income Ratio
When a lender evaluates you for a home loan, it looks for a range of information about you, your finances and your ability to repay the debt. It also looks at your debt-to-income ratio. This ratio represents how much of your income you spend on monthly debt payments.
For example, if you currently earn $4,000 per month and pay $400 for regular debt obligations, you have a debt-to-income ratio of 10 percent. Mortgage lenders prefer your ratio be no more than 36 percent. If a car loan would push your debt-to-income ratio too high, the mortgage lender may not approve your loan.
Credit Scores and Rates
Information on your credit report determines your credit score, which is a number that represents how reliable a borrower you are. Your score can decrease when you apply for a new loan or when you are accepted for one. One of the ways lenders use credit scores is to determine what kind of interest rate to give you when you get your loan. Getting a car loan can drop your credit score and thus result in the lender giving you a higher interest rate.
Paying in Cash
Of course, if you buy either your car or your home with cash, meaning without obtaining a loan, there will be no debt to go on your credit report. If, for example, you apply for a mortgage loan and buy a car with cash, the mortgage lender will not see a change on your credit report or credit score. However, mortgage lenders also look at how much cash you have in the bank, so using up your savings to buy a car can also negatively impact your chances for loan approval.
Roger Thorne is an attorney who began freelance writing in 2003. He has written for publications ranging from "MotorHome" magazine to "Cruising World." Thorne specializes in writing for law firms, Web sites, and professionals. He has a Juris Doctor from the University of Kansas.