Navigating the world of finance can often feel like a complex maze. From mortgages to car loans, understanding how one financial decision can impact another is crucial.
One question that often arises is whether having a car on finance can affect your ability to secure a mortgage.
This article aims to shed light on this topic, providing you with a comprehensive understanding of how car finance and mortgages interact.
Understanding Car Finance
Before we go into the impact of car finance on mortgages, let’s first understand what car finance entails. Car finance is a broad term that encompasses several ways of funding a car without paying the full amount upfront. Instead, the cost is spread over a set period, making it more manageable.
Here are the most common types of car finance:
Hire Purchase (HP)
With HP, you pay a deposit upfront, then make monthly payments over a set period, typically between 12 and 60 months. The car is yours once you’ve made the final payment.
Personal Contract Purchase (PCP)
PCP is similar to HP, but at the end of the agreement, you have the option to return the car or make a final payment (often referred to as a balloon payment) to own it outright.
Personal Contract Hire (PCH)
With PCH, you essentially rent the car for a set period, typically between 12 and 48 months. At the end of the agreement, you return the car.
Personal Loan
While most people seem to prefer PCP finance, many others still use an unsecured personal loan from a bank or building society. You pay a fixed amount each month for a set period of time.
Each of these options has its pros and cons, and the right choice depends on your personal circumstances and financial goals.
The Relationship Between Car Finance and Mortgage Applications
When you apply for a mortgage, lenders look at your financial commitments, including any car finance payments.
Why?
Because lenders need to assess your ability to repay the mortgage. Car finance, like any other form of debt, can affect this assessment because it is a fixed credit commitment.
The Impact of Car Finance on Your Mortgage Application
Lenders calculate your affordability for a mortgage based on your income and outgoings. If you have a car on finance, the monthly payments are included in your outgoings. This will affect the amount you can borrow for a mortgage.
For example, let’s say you earn £40,000 per year and have a car finance payment of £200 per month. Lenders will consider your income as £36,400 (£40,000 – (£200 x 12)) when assessing your mortgage affordability. This reduction in perceived income will lower the amount you’re able to borrow for a mortgage.
Some advanced planning can help your mortgage situation. If your car finance is due to renew around the time you want to apply for a mortgage, consider delaying it by a few months. If there’s very little time left the lender is likely to ignore the monthly payment when assessing affordability. So you can borrow more.
If there is still a need to renew the car finance then this must be done after the new mortgage completes, and not before. Lenders are known to carry out last minute credit checks before they hand over the money.
Positive Impacts of Car Finance on Mortgage Applications
While car finance is a form of debt, it’s not all doom and gloom.
If managed responsibly, car finance can have a positive overall impact on your mortgage application. Making your car finance payments on time will, over time, improve your credit history. A good credit score can enhance your chances of securing a mortgage, as it demonstrates to lenders that you’re more likely to be a reliable borrower.
Negative Impacts of Car Finance on Mortgage Applications
On the flip side, missed or late car finance payments can negatively impact your credit profile. A poor credit score can hinder your ability to secure a mortgage, as lenders may view you as a higher risk.
No credit history
Getting a mortgage with no credit history is also a bit tricky. Lenders have no track record of monthly payments to help them assess your affordability. In this situation you have a thin credit file.
Tips for Managing Car Finance When Applying for a Mortgage
If you’re planning to apply for a mortgage while having car finance, here are some tips to improve your chances:
Pay Off Your Car Finance
If possible, try to pay off your car finance a few months before applying for a mortgage. This will reduce your monthly outgoings, improve your affordability and lower your debt-to-income (DTI) percentage.
Reduce Your Car Finance Payments
If you can’t pay off your car finance, consider reducing your monthly payments by extending the term of the agreement. This could lower your monthly outgoings and potentially improve your mortgage affordability.
Improve Your Credit Score
Always make all your car finance payments on time, pay off any outstanding debts, and check your credit report for errors. These actions can help improve your credit score, which can enhance your chances of securing a mortgage.
Consider a Smaller Mortgage
If you have a large car finance payment each month, consider applying for a more manageable mortgage or saving up a larger deposit to reduce the size of the mortgage. This could make your mortgage payments more manageable and increase your chances of approval.
In conclusion, having a car on finance can indeed affect your mortgage application.
However, it’s not always a solely negative impact. If you manage your car finance responsibly and make all your payments on time, it can even improve your chances of securing a mortgage. It’s essential to consider all the factors involved and take steps to improve your affordability and credit score.
Remember, every financial decision you make can have implications, so it’s always wise to think ahead and plan accordingly.
Navigating the world of finance may seem daunting, but with the right knowledge and understanding, you can make informed decisions that align with your financial goals. Whether you’re considering car finance, a mortgage, or both, remember to consider the potential impacts and plan accordingly.
To find out how your car payments could affect your mortgage borrowing, get in contact with one of our mortgage brokers.
FREQUENTLY ASKED QUESTIONS
Not necessarily. If managed responsibly, car finance can even improve your credit score, enhancing your chances of securing a mortgage.
Yes, making your car finance payments on time and in full can positively impact your credit score, which can improve your chances of securing a mortgage.
Consider paying off your car finance before applying for a mortgage, reducing your car finance payments, improving your credit score, or applying for a smaller mortgage.
All types of car finance are considered financial commitments and can impact your mortgage application. However, the impact can vary depending on the monthly payments and the terms of the car finance agreement.
It’s possible, but missed or late payments can negatively impact your credit score, which can make securing a mortgage more challenging. Depending on the extend of the missed payments, you may need to look for a bad credit mortgage, where the lenders are used to seeing credit issues.
You may have chosen to buy your car with an unsecured personal loan. It’s definitely possible to get a mortgage if you have a personal loan. However, the same rules apply. If the loan is affordable and you have kept up with the repayments then it shouldn’t cause too many issues.
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