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Experts say not to apply for credit before buying a house. But does this apply to car loan refinancing?
Refinancing your car can help you snag a lower interest rate and a lower monthly auto loan payment. But depending on your credit history, refinancing your car right before buying a home can impact your mortgage application.
If you’re not sure what to do first — buy a home or refinance your car loan — here’s what to think about.
Let’s quickly discuss what lenders look at to approve you for a mortgage:
Mortgage lenders use your credit score and credit report to determine if you’re creditworthy. A high credit score means you’re less likely to default, so people with high credit scores are often rewarded with application approvals and better interest rates. The opposite is true for people with low credit scores.
These are the factors from your credit report that are considered in your FICO Score calculation:
The minimum credit score needed for a mortgage varies by mortgage type and program, but in general, you need a credit score of at least 620. If your score could use some work, there are ways to improve your credit, though it may take some time.
Lenders review your income and employment status to ensure that you have a stable source of income to repay the mortgage. To verify your income, the lender might ask for tax records and pay stubs.
If you’re self-employed, you may need to provide two years of tax statements including all schedules.
Lenders use your income and debt to calculate your debt-to-income ratio, which is a percentage that expresses how much of your monthly income goes to paying off debt. Using this ratio, lenders determine the mortgage payment you can afford given your current debt responsibilities.
DTI requirements vary, but generally, mortgage lenders look for a DTI of 43% or less.
To calculate your DTI, add up your debt payments for each month (including the proposed mortgage payment), divide that total by your monthly income, and multiply by 100.
Pre-tax income: $5,000 Total debt payments: $2,090 To calculate your DTI, divide your total monthly debt payments ($2,090) by your pre-tax income ($5,000) and multiply by 100. $2,090 ÷ $5,000 x 100 = 41.8%Example A: Calculate Your Debt-to-Income Ratio
Credit card minimum: $250
Student loan: $500
Auto loan: $500
Mortgage payment: $8404 Ways Car Loan Refinancing Might Affect Your Mortgage Approval
Now that we know what matters in the mortgage application process, here’s how car loan refinancing might impact your approval.
The process of applying for car loan refinancing usually includes a credit check, and it will likely count as a hard inquiry against your credit profile, which can dock your score a few points.
After a credit hit, “You might not qualify for a [mortgage] rate you thought you did before,” said Benjamin Schandelson, a loan originator with MJS Financial LLC in Boca Raton.
The degree to which a hard credit inquiry will hurt your score varies. According to FICO, a hard credit check might reduce your FICO score by as little as five points since the “new credit” factor of your score only has a 10% weight in the calculation.
That said, the hit could be greater for certain people: A hard inquiry might be more impactful if you have few accounts on your credit report and a short credit history.
Car loan refinancing is essentially opening up a new loan account to pay off your existing auto loan. If a new loan pops up on your report before applying for a mortgage, the lender might ask for a letter of explanation as to why you opened the new account.
Making major changes to your debt accounts while in the process of buying a home — such as refinancing a car loan or putting a major purchase on your credit card — means your monthly debt payments might change and the DTI might need to be recalculated. This could stall the closing process.
Plot twist: Refinancing your car loan before buying a house might not only negatively affect your future home purchase. A refinance loan that lowers your monthly payment could also reduce your DTI.
Let’s say that refinancing your car loan dropped your monthly car payment from $500 to $350 in the example above. Here are the new numbers: Pre-tax income: $5,000 Total debt payments: $1,940 To calculate your DTI, divide your total monthly debt payments ($1,940) by your pre-tax income ($5,000) and multiply by 100. $1,940 ÷ $5,000 x 100 = 38.8%
Example B: Calculate Your Debt-to-Income Ratio After Refinancing
Credit card minimum: $250
Student loan: $500
Auto loan: $350
Mortgage payment: $840Pros and Cons of Refinancing a Car Loan Before Buying a House
If you’re trying to decide whether or not it’s a good idea to refinance your car before buying a home, here are some pros and cons.
It depends on your financial situation. “If you can qualify for a mortgage with your current debt and income, we suggest waiting until after buying a home to refinance your car,” said Schandelson.
The one circumstance where car refinancing might actually be beneficial before a home purchase is if you have a high credit score and a high DTI, according to Schandelson. That’s because refinancing for someone who has strong credit could lower the DTI without causing too much of a credit hit.
Schandelson recommends waiting for at least one or two payments into the new auto loan refinance before buying a home. This might take two to four months depending on the terms of the loan.
As far as credit score recovery goes before homebuying, the effect of a hard inquiry might only last a few months for people with good credit. So, if your score is, say, 800 or higher, the handful of points you lose after the credit check could have a minimal impact and you might be ready to buy a home fairly quickly.
For homebuyers with less-than-perfect credit, the hard pull could affect you for up to a year. Ultimately, how long you decide to wait to buy a home after car refinancing depends on factors like your credit, but also external factors like mortgage rate trends and the housing market.
Mortgage rates are low at the moment, even for borrowers without perfect credit, so that could motivate you to buy sooner than later. A financial advisor or real estate agent can give you advice on when the right time is to buy given your circumstances and market conditions.
Yes, it’s possible to refinance your car after buying a home. In fact, you might find that auto lenders are a bit less stringent with qualifying criteria than mortgage lenders.
For example, you might be able to qualify for car loan refinancing with a DTI as high as 50%, but DTI requirements can also vary from one lender to another.
If you’re not able to get approved for car loan refinancing that has a competitive rate with one lender, you can always shop around for rates with others. Consider shopping with banks, credit unions, and alternative lenders to see what each type of financial institution has to offer you.
The best way to figure out whether you should refinance your auto loan or buy a house first is to start comparing different scenarios. You might be able to speak with lenders and pre-qualify for loans with just a soft inquiry that doesn’t affect your credit. Based on the preliminary offers you get, you can make a decision on what will be the right move for you.
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