Buying a house is a huge financial commitment, and depending on your financial situation, you may need to take out a mortgage to make it happen. But if you have an auto 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, typically from a different lender. Refinancing can reduce your monthly payments by extending the loan term or getting a lower interest rate.
So, should you refinance your car loan before buying a house? There's no right or wrong approach. However, it's important to weigh the pros and cons of each option before you make a decision.
Is refinancing right for you? Easily compare rates from lenders below.
How Car Loan Refinancing Can Impact Your Mortgage's Approval
If you choose to refinance your car loan, it can affect your mortgage approval in a few 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, this drop in credit can make it harder to get approved for a mortgage. The good news is that the dip is only temporary and should improve as you make timely payments.
More Paperwork
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 account could raise questions from your mortgage lender.
In addition to the standard paperwork you have to fill out when applying for a home mortgage, the lender may also require you to provide a letter explaining the reason for the new account and why you opened 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 reduce your monthly payments can also reduce 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 is, the better your chances of getting approved.
Cash for Home Down Payment
Some auto lenders will allow a cash-out refinance if you owe less than the vehicle's value, which will give you some 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 auto loan amount. This increase could impact your DTI, as the auto lender may require you to make larger monthly payments.
Pros and Cons of Car Loan Refinancing Before Buying a Home
Now that you have an idea of how refinancing an auto loan can impact your chances of getting a mortgage, let's take a closer look at the pros and cons of refinancing first.
Pros
- You Can Get a Better Rate on Your Auto 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 that money you saved toward the down payment on your new home, as well as mortgage fees and closing costs.
- The Effect on Your Credit Score Is Minimal: While a hard credit inquiry will certainly affect your credit score, it's not usually significant. This is especially true if you have a good credit score already. In this case, the slight dip in your credit score shouldn't dramatically affect the odds of a lender approving your mortgage or the rate it will offer.
- You Lower Your DTI for Better Chances of Mortgage Approval: Refinancing your auto loan to lower your monthly car payment may decrease your DTI. A low DTI not only increases the chances of getting approved for a mortgage, but it also helps you secure a better interest rate.
Cons
- The Hit to Your Credit Could Be Significant: The hit to your credit score when refinancing your car loan can be pretty significant if you have a short credit history, few accounts, or multiple hard credit inquiries on your report. Add in the hard credit inquiry when you apply for a mortgage and the odds of a lender approving your mortgage go down.
- Refinancing Costs: If you are refinancing an auto loan with a new lender, you'll need to pay origination fees and costs. If you refinance with your current auto lender, you may face charges for closing your original car loan before the loan term expiration date. These costs can add up and reduce your potential savings.
- Spending More in Monthly Payments: When you refinance your car loan, you can extend the loan term. But while the monthly payments will be lower, you typically pay more in interest over the entire loan period. You could end up paying more over the lifetime of the loan after refinancing. As such, refinancing an auto loan may not be the best move if you're close to paying off the loan.
When and When Not to Refinance an Auto Loan Before a Home Purchase
Should you refinance your auto loan before buying a home? Like other big decisions, the answer depends on your financial situation.
Refinancing your auto loan before buying a home may be the best move if you have a high DTI and an excellent credit score. Why? Refinancing under these circ*mstances could lower your DTI while sparing your credit score from a significant hit.
On the other hand, if you qualify for a mortgage with favorable terms with your current income, credit score, and DTI, waiting until after you've bought a house to refinance your auto loan may be a better option.
Best Time to Refinance Your Car
Timing is everything when you're looking to refinance your auto loan and get a mortgage. Consider your financial situation, current car loan interest rates, and your equity in the vehicle.
It may be an excellent time to refinance your car loan if any of the following apply:
Your Finances Have Improved
If your income or credit score has improved since taking out the car loan, it can work in your favor. This will reduce your risk profile and may encourage your lender to offer you a better interest rate.
Interest Rates Have Dropped
If interest rates have gone down since you first got your car loan, refinancing can get you a better rate and help you save money. You can then work toward saving up enough for a down payment on the house and the mortgage closing costs.
You Have Positive Equity
The value of your car generally depreciates over time. Consider refinancing your auto loan if you have positive equity, which means you owe less on the loan than what 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 might wait to buy a home until after you refinance your auto 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 paying your bills on time and in full. This might take several weeks or several months.
On the other hand, your credit score might not recover as fast if you have bad credit. It could take much longer for your credit score to rebound after refinancing your auto loan. This will inevitably stall the process of purchasing a house.
Trends in the mortgage market should also inform your decision. If market rates are high, consider waiting until they go down. If you are refinancing your car loan to qualify for a mortgage, be sure to check with the mortgage company. Depending on the lender, it's possible to exclude car payments from your DTI. This may be helpful if you're almost done paying off your loan.
After refinancing, it's generally recommended that you make at least a few payments before buying a house. How long you wait will depend on your circ*mstances and mortgage market conditions. That said, it's best to seek professional advice from a financial advisor or a 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 choice for you, you can always hold off on refinancing until after you've bought a house.
As long as you meet the criteria, you can apply for a refinancing loan at any time. Auto lenders are typically more accommodating when it comes to eligibility criteria than mortgage lenders. Shop around until you find a lender that will refinance your car loan at a competitive rate.
Explore Your Options
For most people, buying a house before refinancing a car loan is generally a better option. However, there's no right or wrong approach to refinancing your car loan and buying a home.
It's a good idea to speak to a loan officer or mortgage broker to get a better idea of how refinancing your vehicle could hurt or improve your chances of getting a mortgage.
Elizabeth Rivelli is a freelance writer with more than three years of experience covering personal finance and insurance. She has extensive knowledge of various insurance lines, including car insurance and property insurance. Her byline has appeared in dozens of online finance publications, like The Balance, Investopedia, Reviews.com, Forbes, and Bankrate.
