Whether a car loan will affect your ability to get a mortgage depends on your financial capacity and what kind of property you plan to purchase.
If you are hoping to stretch the limits of what you can afford then any debt you can retire prior to applying for a mortgage will help.
In this article, we will discuss what aspects of a mortgage application are affected by a car loan and how you can manage these to ensure you get the outcome you want.
In This Post:
The Effect a Car Loan Has on Your Credit Profile
The first issue to consider is how a car loan changes your financial situation when applying for credit.
Each of these changes is relevant to a new loan application, but the impact is amplified when applying for a mortgage due to the size of the loan and multi-decade repayment terms.
Total Debt
The higher your total debt the more cautious a lender will be when assessing your loan application.
A credit assessment will be conducted based on your current debt plus the debt you are applying for.
When you have a car loan outstanding then the current debt part of this equation starts out at a higher level.
Cash Flow
The more debt you have the higher your repayments.
A credit assessment will consider your disposable income after your current obligations are met.
If you are already committed to making car loan payments then this reduces your available cash flow to support any new debt.
It does not matter how long you have left to repay your car loan.
Even if you only have three payments left, and lender is obligated to assess your cash flow based on your capacity to pay today due to the Responsible Lending regulations.
Credit History
A car loan will influence your credit score depending on how well you have managed this loan, how recent the application was, and who your creditor is.
If you have made all of your repayments on time over a number of years then it is likely that your credit score may have increased.
This may assist you access more home loan options.
However, if you have missed payments then this may hurt your credit score.
Even if you have repaid any arrears on your loan, this may still be visible on your credit file and a new lender will be able to see the blemish on your record.
Australia is in a transitionary period away from negative credit reporting. This is where only credit inquiries and negative events (such as a default, judgment, or bankruptcy) would be visible detractors.
Under the new Comprehensive Credit Reporting (CCR) regime, a snapshot is taken every month of the status of your current open loans.
So if you fall into arrears at any point in time it will be visible on your CCR file.
How This Affects a Mortgage Application
Now that you understand the elements of a credit application we can now look at how this applies when you are assessed for a mortgage.
Debt-to-Income Ratio
All mortgage lenders will have a policy for your maximum debt levels in relation to your income.
For example, if the policy states that your borrowing limit is five times your income and you earn $100k per year, then your total debt levels cannot exceed $500k.
If you already have a car loan with $30k owing, then your maximum home loan would be $470k.
If you had no car loan outstanding then you could put the full $500k towards purchasing a home.
Serviceability
Your serviceability calculation is what often surprises people the most.
The power of your cash flow is enormous when directed to a mortgage due to the lower interest rates compared to a car loan.
For example, let’s compare the debt-free option using the same income level to an individual who is directing $600 a month to an existing car loan:
- Debt Free: $538,600
- With Car Loan: $442,400
That is a difference of nearly $100k in additional borrowing power and a significant change in the type of property you will be able to purchase.
This is a simplified example of course and the outcome will vary between individuals and lenders. But it does highlight the importance of planning ahead.
We’ll discuss ways to improve your serviceability shortly, but if you have a car loan there will be an impact but it can be managed in most cases.
Credit Score
The move towards CCR has also encouraged a greater reliance on your credit score for the purpose of loan eligibility.
Now, the number of variables that influence this is far too great to cover in this article.
However, if you have taken out a car loan and repaid it in full and on time then your credit score should go up.
So you may be better off with the car loan depending on how long you have had it. If you can also meet the serviceability requirement for your desired property then no problem.
It is the combination of factors that makes a difference, and it is important to note that having a car loan does not necessarily affect your mortgage application in a negative way unless you are pushing the limits of your capacity.
How To Improve Your Mortgage Eligibility
If you are applying for a mortgage then chances are you have accumulated savings to pay for the deposit on a house.
This means you have options for how you will manage your car loan to maximise the strength of your mortgage application.
Early Repayment of Loan
You could simply pay off your car loan early. This is likely to incur an exit fee but it may be a small price to pay to maximise your potential mortgage limit.
You will lower your total debt and free up the additional cash flow that is currently going towards your car repayment.
However, if you need to preserve your savings for that deposit then the priority may shift to getting the best deal possible on your car loan.
Refinance to Lower Repayments
There are two outcomes from refinancing your car loan that can significantly improve your mortgage application.
- Move to a lower-interest loan to save costs and lower repayments; or,
- Extend your loan term to the maximum possible to minimise your repayments.
Both options can free up a significant amount of cash flow.
If you would like to discuss your options to refinance then submit an inquiry below and our expert team will be in touch.
Sell Your Car
This may sound extreme, but can you go without a car for a couple of months?
Public transport and rideshares are not too bad if you live in a city area and may actually work out cheaper than just running your car.
Once you have unconditional approval of your mortgage and a signed contract to buy a property you can then just buy another car.
Car lenders are a bit more flexible than mortgage lenders due to the shorter relative loan terms and higher costs.
So you can apply for a car loan almost immediately after buying a house.
New house, new car… Life is good!
Conclusion
A car loan is just another thing to be managed when applying for a mortgage that is dependent on your financial position and goals for your property purchase.
For many, it will make no difference. Others may need to consider paying down the loan, refinancing, or selling their car to ensure they get the best possible outcome to their mortgage application.
At Gusto Finance we specialise in the auto lending side of things and may be able to help you get a better deal on your car loan while searching for your new home.
So get in touch today and we’ll provide you with a free assessment.
