Should I Buy A Car Or House First? How To Decide

Ah, adulthood: an entire world of new possibilities and financial decisions. If you’re in the fortunate position of having steady income and a little bit in the bank, you may be wondering if you should buy a car or a house first. The answer depends on your own set of circumstances, but if you’re worried about a car loan impacting your ability to qualify for a mortgage, read on.

Should I Buy A Car Or House First?

Whether to buy a car or house first is a personal choice that depends on the borrower’s goals, their financial situation, how long you expect to be keeping a car or living in that home, and which of the two is a more logical first purchase. You might need a car to get to work, or you might be moving to an area where you can do without one for some time. Keep in mind that any additional loans taken out can affect your debt-to-income ratio and credit score, ultimately impacting your next purchase.

How Does A Car Loan Affect Your Ability To Get A Mortgage?

When reviewing a home buyer’s credit worthiness, lenders look at all existing loans: car loans, student loans and personal loans as well as revolving credit card debt. Lenders are especially interested in car loans as these are monthly payments that can affect a buyer’s ability to meet their mortgage payments.

Car Loan Vs. Mortgage: Impact On Credit

Whether applying for a car loan or a mortgage, you’ll need a good credit score. Typically, lenders look for a minimum credit score of 620 for conventional loans and 580 for FHA or VA loans. Having a car loan on your credit file will impact the following:

• Amounts owed (30% of credit score)
• Payment history (35% of credit score)
• Length of credit history (15% of credit score)
• Credit mix (10% credit score)

An individual's credit score is made up of a mix of factors, but making on-time payments is the biggest part of your score and the most important factor. Making timely auto loan payments will go a long way toward showing home lenders you are a trustworthy borrower, especially if you had a thin credit profile prior to obtaining an auto loan.

If you have a low score or are working to build credit for the first time, buying a car may be the better first step.

Car Loan Vs. Mortgage: Impact On DTI

While having an auto loan certainly won’t keep you from homeownership, it will impact how much home you can afford or how big of a mortgage you’ll be able to take on. This all comes down to your debt-to-income ratio (DTI) and your income.

Here’s a very simple example of how debt-to-income ratio works. This example assumes that the lender needs the borrower to maintain a DTI ratio of 37%, but your DTI may be higher or lower depending on other qualifications and the loan option you’re applying for. Other assumptions include a 15% down payment and 3.25% interest rate.

• Alex is a homeowner who makes $40,000 per year before taxes, or a gross income of $3,333 per month. Alex is debt free, except for a $20,000 loan on their car, which let’s say comes to $360 per month.
• To get a rough DTI calculation, just divide Alex’s debt ($360) by their gross monthly income ($3,333) and you get a debt-to-income ratio of 11%.
• After factoring in their auto loan, a lender would qualify Alex for a rough monthly housing payment of up to $873.21, or a home priced around $200,642 or less (depending on interest rates at the time of borrowing).
• If Alex had a more expensive car with a $35,000 loan (a $630 monthly payment) or owed money on student loans, keeping the DTI the same would qualify Alex for a monthly mortgage payment of $603.21, or a home in the $163,000 price range.

The example above illustrates how it isn’t necessarily about the price of what you’re buying when you borrow money. Instead, it shows how the cumulative amount you can afford to pay across all your debt obligations affects how much you can afford.

Importance Of Budgeting

While a house is probably the most expensive thing you will ever budget for, a car can also require a significant amount of cash. Finding the right car or home for your needs must be balanced with your budget.

Car Loan Vs. Mortgage: Realistic Budget

A realistic budget is necessary for any financed purchase. You aren’t just paying once, so you must consider your income stability and plan a long-term budget. When it comes to a mortgage, the standard suggestion is that you pay no more than 28% of your monthly income on mortgage payments. For a vehicle, the suggestion is that you pay no more than 10% of your monthly income.

Down Payments For Cars Vs. Homes

The need for a 20% down payment on a mortgage is an oft-quoted myth. Houses can be bought for as little as no down payment depending on the loan used, though you can expect 3% to 3.5% to be the minimum allowed for most loans. VA loans from the Veteran’s Administration and USDA loans offer no down payment, and usually come with lower interest rates if you are eligible. Rocket Mortgage^® does not offer USDA loans at this time.

On the other hand, cars bought with zero down payment generally come with higher interest rates and greater risks given how quickly cars depreciate. The standard rule of thumb when it comes to vehicles is a 20% down payment.

Car Loan Vs. Mortgage: Monthly Expenses And Payments

Both car loans and mortgage payments will include interest, but other monthly expenses will differ. Property taxes and home insurance payments must be factored in when determining mortgage payments. Meanwhile, car loans might come with sales tax depending on your state. You might also need or want car insurance, which can be expensive for newer models. Both will involve both regular and unexpected maintenance costs. The minimum suggested amounts for this are 1% of the home value put aside annually and at least $50 a month for car repairs.

Car Loan Vs. Mortgage: Impact on Loan Terms And Rates

Car loan terms are much shorter than those of mortgages, the standard maximum being 84 months with rare exception. While the average length is 67 – 69 months, it’s suggested you stick to vehicles you can pay off within 48 months. Meanwhile mortgage terms can be shorter than ten years, though this is rare. Most mortgage loans are 15 or 30 years.

Interest rates for the two loans also differ. Interest rates for cars are often significantly higher, ranging from 10% to 17% depending on a variety of factors, mainly your credit score and whether the car is new or used. When it comes to mortgages, you can expect rates below 10%. Over the last 6 years, the average rates ranged from as low as 2.2% to as high as 7.57% on 15- and 30- year mortgages. These interest rates also consider a number of factors beyond your credit score, such as loan type and home location.

FAQs For Deciding Whether To Buy A Car Or House First

While home buying may be the better long-term investment, it may not be tenable to get by in your location without a car. Deciding whether to buy a home or a car first comes down to the following considerations and frequently asked questions.

Do I need a car for my current lifestyle?

If there are few public transit options in your area and you need a vehicle to get you reliably to and from work, then it’s important to buy a car first. You can’t build wealth without employment!

Is home buying affordable in my area?

If you live in an area where real estate values are high, purchasing a home may be unattainable as a first-time buyer on an entry-level salary. Often, the answer to the question, “Should I buy a home or a car first” is out of necessity – it’s easier and faster to save the down payment on a $20,000 purchase than a $200,000 one, so naturally many opt to obtain a vehicle first.

How much money do I need to have in savings?

This will depend on whether you’re planning to buy a house or a car first, and how much of a down payment on your purchase you want to have. If you have a decent amount of savings, you might have enough to instead buy a car without having to finance it at all, which can result in less interest and one less monthly bill to worry about. On the other hand, you might prefer to use that money for a sizeable down payment on a house, which can result in more equity in the home when you do buy, pay less in interest over time and avoid private mortgage insurance that is required when buying a home with less than 20% down.

Should I wait to refinance my auto loan if I want to buy a house?

While refinancing offers benefits such as lowering your monthly payment and overall debt-to-income ratio, there’s a reason that real estate agents, mortgage brokers and financial experts recommend home buyers put off all major purchases until after closing – it can seriously derail a real estate transaction!

Here’s why: When you apply for a loan (whether it’s new debt or a refinance of an existing loan), it impacts your credit score. A hard inquiry could potentially lower your score, and any new lines of credit will impact your overall debt-to-income ratio.

Since lenders offer home loan interest rates based on your score, if your score changes at the last minute, so will your interest rate. Then, the underwriters at the bank have to go back and underwrite your loan all over again.

Not only could your interest rate increase, but any last-minute credit score shake ups will definitely delay closing on your house.

The Bottom Line: Buying A Car Or A House First Depends On Your Needs And Goals

Whether you buy a home or a car first really comes down to your lifestyle, the accommodations in your area (like public transit) and your own personal financial goals. There’s really no bad way of hitting these important financial milestones, so long as you’re smart about the timing and protecting your credit along the way.

If you’re ready to consider applying for a mortgage and buying a home, learn how to get preapproved for your loan today.

If you’re ready to move forward with buying a home, you can start an application online.