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Will my car loan affect my mortgage application?

Mark Bristow avatar
Mark Bristow
- 7 min read
Will my car loan affect my mortgage application?

A car loan may positively or negatively affect your mortgage application. Successfully managing your car loan repayments could help improve your credit score, which may make a better impression on mortgage lenders. But if your car loan would push your debt-to-income ratio too high, a lender may be less likely to approve your mortgage application.

How can a car loan affect my credit score?

Mortgage lenders and other credit providers use credit scores to quickly assess the risk of lending money to individuals. A high credit score could mean you’re more likely to be approved for a lower interest rate, while a low credit score could see you paying a higher interest rate, or your credit application could be declined altogether.

Under the comprehensive credit reporting (CCR) system, consistently making timely loan repayments may help to boost your credit score. If you took out a car loan a couple of years ago and you have been repaying it consistently for many months, your credit score may have risen over this time, as you’ve been demonstrating positive credit behaviour. This could potentially improve your home loan application’s chances of approval, provided you also meet the lender’s other home loan eligibility criteria.

However, late payments (e.g. payments that are not paid within the 14-day grace period of the due date) are recorded on your credit file in this system. If a payment of over $150 is more than 60 days overdue, it is listed as “default” in your credit history and remains on your credit file for five years. This could adversely affect your credit score and home loan application.

Additionally, when you apply for a car loan, the application will appear on your credit report as a hard credit check. If you apply for multiple credit products over a short period, multiple credit inquiries will appear in your credit history. This could drive your credit score down, as it may appear to lenders that you’re desperate for finance and struggling to manage money. This could lead to your applications for car loans and other credit products being rejected.

How does a car loan affect my debt-to-income ratio?

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.

If you can comfortably afford both a car loan and a mortgage, plus your other expenses, your car loan is less likely to interfere with your mortgage application. But if you try to borrow more money than you can afford to repay, lenders might consider an outstanding car loan, or any other debt for that matter, a red flag.

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. You can estimate your own DTI by dividing the total amount of money you earn by the total of all your debts and liabilities, including credit cards, existing car loans, personal loans and more.

A DTI of 3 may be within the lender’s limits and you may be eligible for finance, provided you meet their other terms. A DTI over 6 is often considered high-risk, as you could find yourself in financial hardship if interest rates were to rise suddenly or your financial situation was to change, such as if you lost your job.

An outstanding car loan can also affect 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. If you already need to make a large repayment 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.

Example

Imagine you’re applying for a home loan of $600,000 with your spouse. Your combined household income is $200,000, and you have a 20% deposit saved up for your purchase.

You both have credit cards with $2000 limits that you use for rent, bills and food. Lenders typically consider a credit card’s maximum limit in their calculations, rather than the current balance owing, as they assume a ‘worst case scenario’ where you’ve maxed out your cards.

In this case, your combined liabilities would be:

  • A combined monthly spend of $4000 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 3. In other words, your yearly income is about a third of what your total debt would be.

Now let’s assume you also 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.

This example is for illustrative purposes only and won’t always match how lenders assess individual decisions.

Will a novated lease affect my mortgage application?

Having a novated lease on your car means that your employer pays the lease on your vehicle, as well as its running costs, out of your pre-tax salary, also known as a salary sacrifice.  

A novated lease is less likely to affect your home loan application as much as the monthly repayments on a car loan could. However, a salary sacrifice will reduce your overall income, which could potentially bring down your borrowing capacity as there’s less money available to go towards mortgage repayments.

Can I take out a car loan after my mortgage application is approved?

People often space out big loan applications due to their effect on your credit score. For example, if you plan on applying for a mortgage soon, you may choose to avoid applying for any credit in the preceding few months. Similarly, after you have applied for a mortgage, you may choose to wait until well after settlement to apply for new credit like a car loan.

Some 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 could derail your mortgage application.

Once the loan amount is disbursed and you’ve owned your home for some time, it’s also possible to cash out your built-up equity by borrowing money to purchase a car. Using an equity home loan for a car gives you the advantage of relatively low interest rates compared to many car loans, as well as 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 more 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.

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Product database updated 22 Jun, 2024

This article was reviewed by Personal Finance Editor Alex Ritchie before it was published as part of RateCity's Fact Check process.