How car finance affects your mortgage
When you apply for a mortgage, lenders will take a thorough look at your finances, both past and present. This includes any outstanding car finance deal you have and any previous agreement, even if you’ve long paid off the vehicle.
Car finance agreements are a form of debt, and your timeliness and diligence in making payments on them - or not - will impact your credit score for years to come. Late payments and defaults on car finance loans can damage your credit history. This may mean you won’t qualify for the best mortgage deals or that you’re unable to obtain a mortgage at all.
For more information about how car finance can impact your mortgage application and how to preserve your credit score when financing your vehicle purchase, read on.
In This Guide:
- How does car finance affect your credit score?
- How does car finance affect affordability assessments?
- How to protect your finances when taking out car finance products
How does car finance affect your credit score?
Credit reports are a record of your financial dealings over the last few years. This includes any lines of credit or loans you’ve taken out such as for car finance, your payments on them and other bills, and any defaults on loans or bankruptcy. Your credit report is used to generate a credit score, which mortgage lenders will examine when deciding whether to offer you a loan and at what interest rate.
The better your credit score, the more financially responsible and trustworthy you appear to the lender. They will see you as lower risk and reward you with more mortgage options, including those with the lowest interest rates.
If you have a poor credit score, you’ll be eligible for fewer mortgages and generally only those with higher interest rates. In some cases, your credit score will be so weak that you’re unable to obtain a mortgage at all.
Making late payments on car finance deals or defaulting on those agreements can damage your credit report and score, even years after you’ve paid off the car. In some cases, you may find yourself ineligible for the most competitive mortgage deals, or for a mortgage entirely, because you fell behind on a previous car finance arrangement.
On the other hand, regular payments on a car finance product, as with other lines of credit, can help build your credit score.
How does car finance affect affordability assessments?
Mortgage lenders will also ask for information about your current finances, including bank statements, when assessing your eligibility for a loan. They’ll be especially interested in your regular outgoings, including bills and payments on debts. This will include payments on your car finance deal. Paying a large amount each month for your vehicle reduces the amount of money you have at your disposal to make hypothetical mortgage payments and thus the amount of money a mortgage lender will extend to you.
Mortgage lenders are also concerned with your debt to income ratio. If you hold a large amount of debt relative to your salary, they’ll be worried about lending you more money.
In some cases, if you have the cash handy, it might be a good idea to clear the balance on your car finance arrangement. This way, the monthly repayments won’t affect your ability to pass affordability tests for a mortgage.
How to protect your finances when taking out car finance products
Few of us can avoid using finance to purchase a vehicle. Holding debt in the form of car finance won’t prevent you from getting a mortgage - provided you borrow responsibly and make the payments diligently.
To ensure your car finance deal doesn’t wreck your chances to buy a home, abide by the following rules:
- Only borrow as much as you can comfortably afford. Don’t splash out for the most expensive vehicle on the market, even if you qualify for the financing on it. Borrowing sensibly will ensure you have enough income left over to pass mortgage lenders’ affordability tests. It will also ensure that you can easily make your repayments each month and don’t default on them.
- Choose your car finance product carefully. Avoid taking out a car finance product with high-interest rates and other fees and extras. This will inflate your monthly costs and increase the risk that you’ll miss payments or default.
- Make car payments on time. Timely loan payments will improve your credit score while late payments will ding it.
- Clear the balance on your car finance. If you can afford to, clearing debt will improve your debt to income ratio and increase your available monthly income. This will make you more attractive to mortgage lenders. If you can’t pay off your car loan right now, it might be worth delaying your mortgage application until you have. A mortgage broker will be able to tell you if waiting is a good idea, as well as assess your current eligibility for mortgage products.