Buying a House or a Car: What to Consider

For many people, their cars and their house are their two biggest life purchases. Often, people also borrow for both. Car loans help people purchase vehicles, and mortgage loans help people purchase houses.

Taking out either a mortgage or car loan can affect your finances in major ways. For example, both your credit and your debt-to-income ratio are affected. This means you may need to be strategic about deciding which purchase to make first.

This guide will explain how to decide whether to buy a house or a car first, as well as why that decision matters.

Should You Buy a Car or House First?

Your life circumstances determine whether you’ll first need to buy a house or a car. For example, some people need to buy a car to get to work but aren't yet in a position to buy a home. Others who live in urban areas with excellent mass transit may not need to purchase a car and will buy a house first.

Still, when you have the opportunity to do so based on your financial situation, it can often make financial sense to buy a house first.

That's because mortgage loan eligibility rules are often more strict and mortgages are also typically a much larger debt. As a rule of thumb, you want to prioritize getting a low rate on your largest loan.

Mortgage lenders look at your credit report and score when deciding whether to give you a loan. They also look at your debt. If you've recently taken out a car loan when you decide to apply for a mortgage, your credit score may be lower. Your debt-to-income ratio will also be higher. Both of those factors adversely impact your ability to get a mortgage.

Buying a Car First

There are some benefits to buying a car first, as well as some downsides.

The biggest benefits of buying a car before you buy a house include:

• Getting affordable, reliable transportation. Your car can help you get to work, take care of your family, or improve your quality of life.
• Building credit. Car loans are easier to qualify for, and a great way to build a strong credit profile and history.
• Qualifying for a good rate. Sometimes car loan lenders offer promotional financing. If you take advantage of a low (or no) interest offer, you can buy a car while keeping financing costs down.

The biggest downsides include the following:

• Buying a car first increases your debt-to-income ratio. Your back-end debt-to-income ratio looks at all your debts, including your new car loan. Because lenders often cap this ratio at 36%, buying a car could make it harder to qualify for a mortgage.
• Buying a car increases your overall debt burden. You will have a new monthly auto payment, which can make comfortably affording your future mortgage loan harder. It can also make it more challenging to save up for a down payment.
• Your credit score could decline. Your credit score includes the average age of your credit and number of new inquiries. When you borrow for a car, the new loan shortens your average age of credit and results in an inquiry on your credit record. Both can make small drops in your credit score, and in some cases affect your mortgage eligibility or the mortgage rate you qualify for.

You need to weigh the pros and cons when deciding which financial decision makes sense for you.

Buying a Home First

Buying a home before purchasing a car can be a good choice if it is financially feasible for you. Here are some of the benefits of purchasing your home first:

• You may be able to lock in a lower home price: Often, but not always, homes get more expensive over time. Purchasing a home sooner, rather than waiting, allows you to buy at today's prices.
• You can start building equity sooner: The sooner you own your home, the sooner you begin building home equity as you make payments. And if property values are going up, you also benefit from home appreciation. Building home equity increases your wealth, so it can help you accomplish your long-term financial goals.

And here are some of the potential downsides:

• You may not have reliable transportation: If you wait to buy a car, you may have to rely on public transportation or driving an older, less reliable vehicle.
• Qualifying for a mortgage can be more challenging than getting a car loan: It may take you longer to save up for a home and get into a financial position to buy. Car loans can usually be obtained more quickly and easily.
• Your monthly costs may be higher: Typically, a mortgage payment costs more than a car payment. So you may commit to higher monthly costs sooner if you buy a home first.

Home Loan vs. Auto Loan: Key Financial Considerations

When you decide whether to get a home loan or an auto loan first, here are some key financial considerations to think about.

Affordability

Mortgage and car loan lenders look at your income relative to your debt to confirm that you can afford to repay the loan. However, you also need to do your own assessment of how a car payment, and a house payment affect your budget.

Car payments are usually lower than mortgage payments. But look at the cost of either or both payments to see if you can comfortably afford to pay the bills without compromising other financial goals.

Down Payments

You typically make a down payment to get approved for a car loan or for a home loan. However, a car loan down payment is obviously going to be much smaller. And you’re much more likely to be able to buy a car with no money down than a house.

While ideally you will put down 20% to buy a home, the average down payment for first-time homebuyers is 10% according to the National Association of REALTORS. This could still mean putting down more than $40,000 on a $415,000 home.

There are no-down payment mortgage options in some cases, if you can qualify for a VA loan or a USDA loan to buy a home. But not everyone can qualify for these options. If you don't, you must make sure you have the required funds.

If you can afford the down payment for a car before a home (and you need a car for your lifestyle), you may decide to purchase the vehicle first. But that could set you back on your home-buying journey.

Length of the Loan

The length of the loan is also important to consider, especially as you need to understand how committing to a new monthly payment affects your budget over the long term.

Mortgage loans typically last 15 to 30 years. You are making a long-term commitment. Car loans have shorter terms. Typically, the maximum car loan term is around seven or eight years.

The good thing is, when you have finished making your mortgage payments, you own your home free and clear, and your monthly housing costs go down. But you still need to make sure you can comfortably afford to pay your mortgage every month for the long term before you buy a home.

Maintenance and Upkeep

Both homes and cars come with ongoing costs. You will need auto insurance or homeowners insurance. You'll also have property tax bills for a home, or car registration fees and annual maintenance costs for a vehicle.

In fact, repairs and maintenance are necessary for both homes and vehicles. This may mean changing your oil in your vehicle or changing your HVAC filters in your home. It can also mean coping with large and unexpected repair costs.

The ongoing costs of homeownership are going to be higher than the ongoing costs of car ownership in most cases. But you also build equity with a home, while a car is a depreciating asset. That means its value almost always goes down year after year.

Consider whether you can reasonably afford these costs before you purchase either a home or vehicle.

What Timing Strategy Works Best for Buying a Home or Car?

Every person needs to make their own decision about whether to buy a home or a car first. However, there is a common strategy that works well for many. It can often increase the chance of approval for both a home and an auto loan by maximizing your chances of having a good credit score for a mortgage.

1. Buy the house: Buying a home first allows you to purchase a property with the highest credit score possible. Since your mortgage is a larger loan, it's more important to prioritize getting the best rate on your home loan than your car loan.
2. Settle in: Once you've bought a home, take the time to settle in and get used to your new mortgage payment. During this time, your credit score will recover from the hit that it took when you got the mortgage.
3. Buy the car: Once you are comfortable with your credit score and confident you can afford the additional monthly payments, move forward with the purchase of the car.

While everyone's financial situation is different, going in this order can make sense since your mortgage lender will consider your car loan when deciding whether to approve you for a loan and allow you to benefit from the lowest possible rates.

How Lenders Look at New Debt

Having the highest credit score possible is important when applying for a loan. And new debt will typically cause a small decrease in your credit since you've taken on a new financial obligation and haven't yet established a positive payment history to prove you can cover it.

Over time, having multiple different kinds of debt and showing you are responsible can end up improving your score. But a recent loan can be a red flag when applying for additional credit, and one you'll typically want to avoid when applying for a mortgage.

Final Thoughts: Buying a Home or a Car First

Before you buy a home or a car, consider what each will cost you and how they will fit into your bigger financial picture. Contact Freedom Mortgage today to speak with a mortgage professional to find out your options for a home loan. We’ll help you fully understand all homeownership costs and find you the most affordable mortgage.