Will Getting A Personal Loan Affect Getting A Mortgage?
Miranda Crace5-Minute Read
UPDATED: July 26, 2023
Buying a house is an important next step for many people as they navigate life, and most people need a mortgage to afford a house. If that’s you, one of the first steps on your home buying checklist should be applying for a mortgage.
The number of outstanding loans you have and the total amount you owe in monthly payments are very important factors in determining your mortgage interest rate and whether you even qualify for a mortgage. This means getting a personal loan can definitely affect your ability to buy a house.
Let’s discuss the ways a personal loan can impact your mortgage application and some strategies you can use to offset the influence of this type of financing.
Considerations For Getting A Personal Loan Before Buying A House
To get a mortgage, you’ll need to meet specific criteria your lender uses for approval. Your credit history and the types of loans you’ve used or are currently using can affect some of these eligibility requirements. Before applying for a mortgage, consider how your personal loan could impact the following factors.
Your Debt-To-Income Ratio
One of the most important factors that mortgage lenders look for with all applicants is their debt-to-income ratio (DTI), which is calculated by dividing the debt you owe in monthly debt payments by your gross monthly income.
DTI comes in two forms:
- Front-end DTI: This ratio is calculated by dividing your total housing costs (principal, interest, taxes, insurance and other housing costs like homeowners association fees) by your monthly income.
- Back-end DTI: This percentage is calculated by dividing ALL of your monthly debt payments by your monthly income.
Here’s an example: Let’s say your total monthly housing costs are $1,000, all your monthly debt payments (including your new mortgage) are $1,500 and your monthly income is $5,000.
- Your front-end DTI ratio would be 20% ($1,000 ∕ $5,000)
- Your back-end DTI ratio would be 30% ($1,500 ∕ $5,000)
Most lenders prefer for your front-end ratio to be lower than 28% and your back-end ratio to be lower than 36%.
Your Credit Score
Besides your DTI, a mortgage lender will evaluate your credit score using a rating system such as the FICO® Score. This scale was introduced in 1989 and uses several credit factors to calculate your three-digit credit score. This means getting a personal loan can affect your credit in a few ways, including:
- Payment history: The biggest factor your personal loan will impact is your payment history. If you make late payments or miss some altogether on your personal loan, your credit score might decrease and potential lenders could see you as a risky borrower.
- Credit mix: Your personal loan can also affect your credit mix, which is the different types of credit accounts you hold. For instance, if you only have revolving debt, getting a personal loan – a form of installment debt – could diversify your credit mix and increase your credit score.
- New credit: Another factor that influences your FICO® Score is new credit accounts. That’s because each time you apply for new credit, the lender will make a hard inquiry that could temporarily drop your credit score.
By understanding these factors, you can better manage your loan’s repayment. And if you make on-time payments, diversify your credit mix and wait for hard inquiries to fall off your credit report, you can limit the effects of your personal loan during the home buying process.
Should You Pay Off Your Personal Loan Before Applying For A Mortgage?
Paying off your personal loan before applying for a mortgage could be a good idea for several reasons.
First, clearing off your personal loan from your credit report will help improve your credit score. But, more importantly, removing your monthly debt payment will help lower your back-end DTI. This change could help you get approved for a home loan or get a better interest rate from lenders on your new home mortgage.
Plus, a lot of extra costs are involved with owning a home, so having one less bill to worry about will improve your peace of mind. If you’re financially able to pay off your personal loan before applying for a mortgage (without impacting the amount of money you have available for a down payment), this will be a wise move.
The Do’s And Don’ts Of Applying For A Mortgage
Before applying for a mortgage, a borrower must realize that some actions are simply a bad idea and abstain accordingly. It’s always best to avoid doing anything that negatively affects your credit report while you’re in the process of buying a new home. This includes:
- Applying for new credit cards
- Applying for any new loans
- Changing jobs or anything that would affect your employment history
- Missing any payments on your current debts
- Depleting your existing savings accounts or drastically increasing your credit card debt
Instead of doing any of the above, focus on making changes that can improve your credit score and financial standing. These changes may include:
- Paying off or consolidating debts
- Building up your emergency fund
- Checking your credit report for incorrect information
- Asking the credit bureaus to remove outdated, negative entries from your report
- Making on-time payments
Taking any of these steps can improve your credit score while making you look like a more responsible borrower. The more lenders view you as a responsible borrower, the easier it will be to secure a mortgage.
Getting A Personal Loan Before Buying A House: FAQs
From the answers to these frequently asked questions, learn more about how personal loans and mortgages can mix.
Can a personal loan help me get a mortgage?
A personal loan can negatively or positively affect your credit score and therefore impact mortgage loan approval. If you manage your repayment well and make on-time payments or even pay off your loan early, you could improve your credit score and make it easier to secure a mortgage loan.
Does having a car loan affect buying a house?
If you’re wondering whether buying a car will affect buying a house or refinancing, the answer is yes. Unless you’re paying all cash for your car, that new car loan will show up on your credit report. And when mortgage lenders check your back-end DTI, that new car loan will drive up your ratio and potentially impact your ability to get a new home loan or one with a better interest rate.
Does a personal loan affect my credit score?
A personal loan will affect your credit score. If you’re regularly making on-time monthly payments, that will have a positive impact on your credit score. But if you’re missing monthly payments or your current balance is near the maximum amount of your loan, that could hurt your overall credit score.
Can I use a personal loan instead of a mortgage?
Since personal loans have lower loan amount limits than mortgages, it will likely be difficult to finance the entire purchase of a home with this type of financing. You also probably won’t be able to use a personal loan for your down payment since most lenders prohibit this practice. However, you may be able to use a personal loan to fund a housing alternative, such as a camper van or school bus conversion.
While using a personal loan can impact your ability to secure a mortgage, this doesn’t mean you won’t be able to buy a home. It might just mean more effort to ensure on-time payments, or it might require paying off your loan early to lower your DTI.
If you want a personal loan now, before you start the home buying process, you can get prequalified today with Rocket LoansSM.
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