When you apply for a home loan, the lender must follow responsible lending criteria to verify your financial situation before approving the loan. If a lender finds you’re having difficulty managing your finances or it would be onerous for you to balance your future home loan repayments and existing debts, they have good reason to reject your home loan application or approve you for a smaller amount in some cases.
For instance, lenders generally use a metric called debt-to-income ratio (DTI), to determine your capacity to repay your home loan comfortably without any financial hardship. To calculate your DTI, you can divide the total amount of money you earn by the total of all your debts and liabilities, including credit cards, existing car loan etc.
As an example, let’s assume you’re applying for a home loan of $600,000 with your spouse. Your combined household income is $200,000, and you have got a 20 per cent deposit saved up for your purchase. You both have $2,000 limits - which you use for rent, bills and food - on your credit cards. In this case, your combined liabilities would be:
- A combined monthly spend of $4,000 on your credit cards
- $600,000 for the new mortgage
Your total debt would equal $604,000 if your mortgage is approved. You can now calculate your DTI by dividing this figure by your annual income ($200,000), which equals a DTI of three. In other words, your yearly income is about a third of your total debt.
A DTI of three may be within the lender’s limits and you may be eligible for finance - provided you meet other terms. A DTI over six is often considered high-risk, as lenders believe it might put you under financial hardship if interest rates were to rise suddenly or something was to change - such as a job loss.
Coming to the question of whether your car loan will affect your mortgage application, let’s return to the above example and assume you have an outstanding car loan of $32,000 and you lost your job, making your combined income $110,000. In that scenario, your total debts would increase to $636,000 and your DTI would increase to 5.78, pushing you closer to the upper limit where lenders are likely to consider you a high-risk borrower.
Again, the above example is for illustrative purposes only and won’t always match how lenders assess individual decisions.
How much does a car loan affect a mortgage?
A car loan may positively or negatively affect your mortgage application, depending on how you manage your repayments. Under the comprehensive credit reporting (CCR) system, making timely repayments consistently is likely to boost your credit score. However, even a single late payment, not paid within the 14-day grace period, is recorded on your credit file in this system. Furthermore, payments late by 60 days or more, and for amounts over $150, are listed as “default” and remain on your file for five years.
Suppose that you took out a car loan a couple of years ago and you have been repaying it consistently for many months. In that case, your credit score will likely go up, which can improve your chances of home loan approval, provided you meet the lender’s eligibility criteria for a home loan. On the flip side, even a single missed payment will be recorded and might adversely impact your credit score and home loan application.
An outstanding car loan also impacts your borrowing capacity. When you apply for mortgage pre-approval, lenders use your DTI ratio and other housing expenses to determine how much you can borrow for a home. In case you have a large repayment to make on your car loan every month, it’s likely to reduce your borrowing capacity, and you might have to downsize or save more money before purchasing your house.
A car loan affects your mortgage application in other ways, too. When you apply for a car loan, the inquiry will appear on your credit report. This will temporarily lower your credit score, but it isn’t a cause of concern if you maintain good credit. However, if your credit score just about meets the lender’s threshold, inquiries may push it lower, which can potentially impact your mortgage rate.
Will a novated lease affect my mortgage application?
Having a novated lease on your car means that your employer pays down the lease on your vehicle, as well as its running costs, out of your salary package in the form of pre-tax and post-tax salary deductions. Typically, the amount owed on a novated lease isn’t likely to impact your home loan application as much as the monthly repayments on a car loan could. Salary deductions reduce your overall income that can potentially bring down your borrowing capacity.
Overall, if you can afford repayments on both your auto loan and mortgage comfortably along with your other expenses, there’s no likely reason for your car loan to interfere with your mortgage application. The problem only arises when you try to borrow more than you can afford to repay, which is when lenders might consider an outstanding car loan, or any other debt for that matter, as a red flag.
Can I take out a car loan after my mortgage application is approved?
People often space out big loans due to the impact they can have on your credit score. For example, if you’re applying for a mortgage in the near future, you may avoid applying for any credit in the preceding few months. Similarly, after you have applied for a mortgage, it may be better to wait out until settlement to apply for new credit like a car loan.
At times, home buyers confuse mortgage pre-approval with finalised approval. It’s important to remember that your credit is monitored up until the closing date. Any large debt you take on during this period that causes your ratios to go over the limit can derail your mortgage application.
Once the loan amount is disbursed and you already own your home for some time, it’s also possible to cash out your built-up equity into borrowed money to purchase a car.
Using an equity home loan for a car gives you the advantage of low-interest rates compared to a car loan and the convenience of making a single monthly repayment. On the other hand, as home loans are long-term loans, it also means you’d be paying off your car over a much more extended period. Despite a potentially lower interest rate, the considerably longer loan term can translate into thousands of dollars in interest charges over the life of the loan.
The choice between refinancing to unlock your home’s equity or taking out a separate car loan depends on your circumstances and preference. You can always contact a mortgage broker to crunch the numbers and understand your options better.