Buying a home is a big financial commitment, and depending on your financial situation, you may need to take out a mortgage to make it happen. But if you have a car loan and are thinking about refinancing, a common question is, “Should you refinance your car before buying a house?”
Refinancing a car loan involves replacing the original loan with a new one, usually from a different lender. Refinancing can lower your monthly payments by extending the loan term or getting a lower interest rate.
So, should you refinance your car loan before buying a home? There is no right or wrong approach. However, it is important to weigh the pros and cons of each option before you make a decision.
Is refinancing right for you? Easily compare rates from the lenders below.
How Car Loan Refinancing Can Affect Your Mortgage Approval
If you choose to refinance your car loan, it can affect your mortgage approval in several ways:
Temporary Drop in Credit Score
When you refinance your car loan, the lender will run a hard credit check, which lowers your credit score.
If you don’t have great credit to begin with, these credit drops can make it difficult to get approved for a mortgage. The good news is that the drop is only temporary and should improve as you make your payments on time.
More Working Papers
Car refinancing involves getting a new loan to pay off your existing loan. This new account will appear on your credit report. When you apply for a mortgage, that new credit score can raise questions from your mortgage lender.
In addition to the standard paperwork you need to fill out when applying for a home mortgage, lenders may also require you to provide a letter explaining the reason for the new account and why you’re opening it.
Impact on Debt to Income Ratio (DTI)
Refinancing your car loan will change your monthly payments by extending the loan term or lowering the interest rate. Refinancing your car loan to lower your monthly payments can also lower your debt-to-income (DTI) ratio.
Mortgage lenders consider your DTI when determining your mortgage eligibility and the amount of money they will lend you. The lower your DTI, the better your chances of being approved.
Cash for Home Down Payments
Some auto lenders will allow a cash-out refinance if you owe less than the vehicle’s value, which will give you a portion of the equity in cash. You can use this money to make a down payment on your new home.
A cash-out refinance, meanwhile, will increase your car loan amount. This increase can impact your DTI, as car lenders may require you to make larger monthly payments.
The Pros and Cons of Refinancing a Car Loan Before Buying a Home
Now that you have an idea of how refinancing a car loan can affect your chances of getting a mortgage, let’s take a closer look at the pros and cons of refinancing first.
- You Can Get a Better Rate on Your Car Loan: You may be able to get a lower interest rate when you refinance your car loan, which can help you save money. Then, you can put the money you saved toward a down payment on your new home, as well as mortgage fees and closing costs.
- The Impact on Your Credit Score Is Minimal: While a hard credit inquiry will definitely affect your credit score, it usually doesn’t matter. This is especially true if you already have a good credit score. In this case, a small drop in your credit score shouldn’t dramatically affect the lender’s likelihood of approving your mortgage or the rate that will be offered.
- You Lower Your DTI for a Better Chance of Mortgage Approval: Refinancing your car loan to lower your monthly car payment may lower your DTI. A low DTI not only increases your chances of getting approved for a mortgage, but it also helps you get a better interest rate.
- The Impact on Your Credit Can Be Significant: The impact on your credit score when refinancing your car loan can be quite significant if you have a short credit history, few accounts or several hard credit inquiries on your report. Add a hard credit inquiry when you apply for a mortgage and the chances of a lender approving your mortgage will decrease.
- Cost of Refinancing: If you refinance a car loan with a new lender, you’ll have to pay the original fees and costs. If you refinance with your current auto lender, you may face charges for closing your original auto loan before the loan’s expiration date. These costs can increase and decrease your potential savings.
- Spend More in Monthly Payments: When you refinance your car loan, you can extend the term of the loan. But while the monthly payment will be lower, you’ll typically pay more in interest over the life of the loan. You could end up paying more over the life of the loan after refinancing. Therefore, refinancing a car loan may not be the best move if you are close to paying off the loan.
When and When Not to Refinance a Car Loan Before Buying a Home
Should you refinance your car loan before buying a home? As with any big decision, the answer depends on your financial situation.
Refinancing your car loan before buying a home may be the best move if you have a high DTI and an excellent credit score. why? Refinancing in these circumstances can lower your DTI while saving your credit score from a significant hit.
On the other hand, if you qualify for a mortgage on favorable terms with your current income, credit score and DTI, waiting until after you buy a home to refinance your car loan may be a better option.
The Best Time to Refinance Your Car
Timing is everything when you want to refinance your car loan and get a mortgage. Consider your financial situation, current car loan interest rates, and your equity in the vehicle.
It may be the best time to refinance your car loan if any of the following apply:
Your Finances Have Increased
If your income or credit score has improved since taking out the car loan, it could work in your favor. This will lower your risk profile and may encourage your lender to offer you a better interest rate.
Interest Rates Have Fallen
If interest rates have dropped since you first got your car loan, refinancing can get you a better rate and help you save money. You can then work towards saving enough for a home down payment and mortgage closing costs.
You Have Positive Equity
The value of your car usually depreciates over time. Consider refinancing your car loan if you have positive equity, meaning you owe less on the loan than the car is worth. Lenders are more likely to offer better terms if you have positive equity because it’s less risky for them.
Waiting to Buy a Home Until After You Refinance Your Car
Depending on your situation, you may wait to buy a home until after you refinance your car loan. But how do you know if this is the right move for you?
Think about how long it will take for your credit score to recover. If you have good credit, your credit score should recover fairly quickly, assuming you continue to pay your bills on time and in full. This may take a few weeks or a few months.
Conversely, your credit score may not recover as quickly if you have bad credit. It may take longer for your credit score to recover after refinancing your car loan. This will definitely hinder the home buying process.
Trends in the mortgage market should also inform your decision. If the market rate is high, consider waiting until it goes down. If you’re refinancing your car loan to qualify for a mortgage, be sure to check with the mortgage company. Depending on the lender, it may be possible to exclude car payments from your DTI. This may help if you are close to paying off your loan.
After refinancing, it is usually recommended that you make at least a few payments before buying a home. How long you wait depends on your circumstances and the state of the mortgage market. However, it is best to seek professional advice from a financial advisor or mortgage broker on the best strategy for your situation.
Refinancing Your Car After Buying a Home
If refinancing your car before buying a home doesn’t seem like the best option for you, you can always delay refinancing until after you buy a home.
As long as you meet the criteria, you can apply for a refinance loan at any time. Car lenders are usually more lenient when it comes to eligibility criteria than mortgage lenders. Shop around until you find a lender who will refinance your car loan at a competitive rate.
Explore Your Options
For most people, buying a home before refinancing a car loan is generally a better option. However, there is no right or wrong approach to refinancing your car loan and buying a home.
It’s a good idea to talk to a loan officer or mortgage broker to get a better idea of how refinancing your vehicle can affect or improve your chances of getting a mortgage.
Finance & Insurance Editor
Elizabeth Rivelli is a freelance writer with more than three years of experience covering personal finance and insurance. He has extensive knowledge of various lines of insurance, including auto insurance and property insurance. His byline has appeared in dozens of online financial publications, such as The Balance, Investopedia, Reviews.com, Forbes and Bankrate.