Will Getting A Personal Loan Affect Getting A Mortgage?
Buying a house is an important next step for many people as they navigate life. And unless you have a rich uncle twice removed who’s fronting all the money for your new home, you’re going to have to apply for and be approved for a mortgage. The number of outstanding loans you have, as well the total amount of monthly payments you have, are very important factors in determining if you can qualify for a mortgage or what your mortgage interest rate would be. So having a personal loan can definitely affect buying a house. Let's discuss how:
Things To Consider When Applying For A Mortgage
Two of the things that mortgage lenders look for with all mortgage applicants applying for a new home loan or refinance are what’s called your “front-end debt to income ratio” and your “back-end debt to income ratio.” Debt-to-income ratio (DTI) is calculated by dividing the amount of your debt (in terms of monthly payments) by your total monthly income.
There are two different kinds of DTI:
- Front-end DTI is calculated by taking your total housing costs (principal, interest, taxes, insurance and other housing costs like homeowners association fees) divided by your monthly income.
- Back-end DTI is calculated by taking ALL of your monthly debt payments divided by your monthly income.
Here's an example. Let’s say your total monthly housing costs are $1,000, all of your debt payments in a month (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)
A good rule of thumb that most home lenders use is that your front-end ratio needs to be lower than 28% and your back-end ratio should be lower than 36%.
Will A Personal Loan Affect A Home Loan?
There are several reasons why paying off your personal loan before applying for a mortgage could be a good idea. First of all, clearing off your personal loan from your credit report will help improve your credit score, and that’s never a bad thing! But more importantly, removing your monthly debt payment will help lower your back-end DTI ratio, which could help you get approved for a home loan or get a better interest rate from lenders on your new home mortgage.
Plus, you’re going to have a lot of extra costs involved with owning a home, so having one less bill to worry about will help increase your peace of mind. If you are 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, it will generally be a good thing.
What Should You Not Do Before Applying For A Mortgage?
There are a few things that you shouldn’t do before applying for a mortgage. It’s generally a good idea to avoid doing anything that affects your credit report while you’re in the process of applying for a mortgage and buying a new home. This includes things like:
- 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
Another example. Let’s say a friend of yours has a credit card that had a 0% promotional APR. He got the idea to max out his card to its $10,000 limit and put the money in an interest-earning Certification of Deposit (CD). He figured he would pocket the interest and make a few hundred bucks over the course of a year. What he didn’t count on was that he soon unexpectedly needed to get a new loan, and having his credit card maxed out was a big negative factor. He ends up losing way more money due to a higher interest rate than he got from his CD arbitrage ploy!
Other Loan Considerations
Does Buying A Car Affect Buying A House?
If you’re wondering whether buying a car will affect buying a house or doing a refinance, the answer is yes. Unless you’re paying all cash for your car (in which case there will be no effect on your ability to get a new home loan for a new house), that new car loan will show up on your credit report. And when mortgage lenders check your back-end income, that new car loan will drive up your ratio and potentially impact your ability to get a new home loan or your interest rate.
Does A Personal Loan Affect My Credit Score?
We’ve talked mostly about whether a personal loan will influence your ability to get a mortgage or home loan, but a personal loan does have an effect on your credit score as well. 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 if your current balance is near the maximum amount of your loan, that could drag down your overall credit score.
Hopefully this article has given you some ideas of whether or not getting a personal loan affects your ability to get a mortgage. A personal loan can make sense depending on your financial situation, but if you’re looking to apply for a new or refinanced mortgage soon, you’ll want to make sure to keep your debt-to-income ratios low and, if possible, hold off on applying for any new loans until after your closing date.
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