Car Loans And Mortgages: Here's What You Need To Know
Buying a new home and a new car are two of the biggest financial decisions we make in our life. Usually, you’ll need to find financing for both. However, what if you already have a loan in place?
If you have an outstanding loan balance, it can become more difficult to receive approval for another one. Read on to learn how lenders will review your financial strength and how factors like credit utilization and DTI-ratio come into play.
How Do Lenders Calculate The Amount You Are Eligible For?
Your credit score and financial strength play vital roles when it comes to getting approved for loans. Usually, lenders review the applicant’s debt-to-income ratio (DTI) to get an estimate of how much they owe and how much they earn each month.
To calculate DTI, lending institutions will add up all of your monthly debt payments and divide it by your gross monthly income. Gross monthly income is the amount you earn before taxes and other deductions. For instance, you pay $1,500 for a mortgage and $500 for the rest of your debts, your total monthly debt payments are $2,000 ($1,500 + $500). Let’s assume that your total monthly income is $5,500. In this case, your DTI is almost 36%.
Most lenders consider anything at or below 36% to be the ideal ratio, anything around 45% as the maximum, and anything less than or equal to 18% as excellent. While some institutions accept higher DTI, they may charge a higher rate of interest.
How Does An Ongoing Mortgage Restrict You From Qualifying For A Car Loan?
Lenders prefer to see a DTI lesser than 36%, with no more than 28% of the total debt going towards servicing your mortgage. A higher DTI indicates that you have a lot of debt, meaning your overall credit utilization is high. This will hurt your credit score since utilization makes up 30% of the rating.
Other than the DTI, some lenders also review your payment-to-income ratio (PTI). It shows the portion of your income taken up by a car loan payment. For instance, imagine you have a gross monthly income of $2,000 (excluding taxes and repayments). In this case, lenders will multiply your pre-tax income by 0.15 and 0.20 to estimate a broad range of expected monthly repayments on the auto loan. A good payment range for an income of $2,000 will be between $360 ($2,000 x 0.15) and $480 ($2,000 x 0.20).
When you take into account recurring payments and other bills, this margin diminishes. If you’re paying off a major portion of your income on a mortgage, your PTI gets lower, thus limiting your chances to qualify for a car loan.
Consider If You Really Need To Buy A Car
If you need a vehicle for commuting, you can consider leasing over buying. Alternatively, you can choose to buy a used car over a new one. Both of these options will help you limit the amount of financing you’ll need, which lowers your credit utilization ratio.
Make a wise car-buying decision. Vehicles depreciate significantly in the first few years of ownership. Therefore, buying a one or two-year-old used car can save between $5,000 and $20,000, assuming the cost of a new one is $30,000. This will help improve your debt-to-income ratio and qualify you for a large amount of mortgage.
Most importantly, the cost of a used car will be lower than that of a new one and insurance premiums also decrease. Along with the borrowing amount, the repayment terms will be flexible. Consider buying the same model, but opting for a used one. This will keep your car payments considerably lower which gives you more financial freedom to manage all your debts.
It’s difficult to qualify for an auto loan when a major portion of your income is going towards mortgages. Make sure to review your finances, especially your credit utilization and debt-to-income ratio before you apply. If you need a car, consider a used one as it’ll lower the total cost. Above all, plan your purchases so you’ve got enough time to repay the existing debt before you apply for new financing.