Can buying a car end your chance to become a homeowner?
The answer has long been no for most households, but times have changed. Between 2000 and May 2024, new and used vehicle prices increased by 25%.
Some of this increase was an inflation byproduct, but there were other causes as well — think of supply chain delays and chip shortages. Meanwhile, during the pandemic buyers were flush with cash because there were not a lot of places to spend money.
Combine fewer vehicles at dealer showrooms with well-healed buyers and you have the perfect formula for higher prices and bigger profits.
“Despite immense challenges during the pandemic and microchip shortage years, dealers will acknowledge it was the best time to be in the new car business, akin to an unforgettable college rager,” explained Cox Automotive in June. “They enjoyed an unprecedented financial boom, with return on sales soaring from 2% to over 6% at most publicly traded auto groups.”
Car prices topped out in 2022, but today’s costs still remain high relative to 2020. One result is that in the second quarter, 17.8% of those who financed new cars were paying at least $1,000 a month, according to Edmunds.
Edmunds adds that the average new-vehicle payment was $740 in the second quarter, the all-time high.
Of course, if you have two or more cars, then monthly auto financing costs can be even steeper.
“High interest rates continued to be a heavy drag on new-vehicle sales growth in the second quarter,” said Jessica Caldwell, Edmunds’ head of insights. “In theory, improved inventory and growing incentives should paint a more consumer-friendly picture of the market, but the reality is most Americans can’t buy their cars with cash, and increased borrowing costs continue to be a major roadblock when buying a new vehicle.”
How Do Auto Loans Impact Real Estate Financing?
All mortgage programs have qualification requirements, such things as minimum credit scores or a certain amount down. One of the big tests is the debt-to-income ratio (DTI).
The DTI looks at what you earn each month versus required payments. It typically has two parts.
The “front” DTI ratio includes only housing costs such as monthly mortgage payments, property taxes, and property insurance. Under the FHA program, as an example, a 31% front-end DTI is acceptable.
In other words, if you have a household income of $8,500 per month before taxes, then FHA lenders will allow you to spend $2,635 on housing costs.
The “back” ratio includes housing costs plus such expenses as required student debt payments, minimum credit card obligations, alimony, and monthly car loan payments. A 43% back ratio is okay with FHA loans, so if you earn $8,500 per month before taxes, that means a back ratio of $3,485 will be acceptable.
If you look at the back-end DTI ratio, you can see how a new monthly debt for a new car, SUV, or pick-up can impact your ability to qualify for a mortgage. Fortunately, there are steps you can take to overcome DTI barriers.
For instance, higher DTI ratios may be allowed if you have such “compensating” factors as a high credit score or substantial savings. In its most recent annual report to Congress, HUD said the average DTI for FHA buyers was 45.1%. With compensating factors, some FHA borrowers can get financing with a 57% back-end DTI.
High DTI levels may sound attractive, but be careful. Big monthly expenses mean there are fewer dollars left for everyday spending. In effect, with a steep DTI you may well be “house poor” and without much money at the end of each month.
Also, different loan programs — such as conforming loans that can be bought by Fannie Mae and Freddie Mac or VA mortgages — have different DTI requirements. Look for the mortgage financing that best meets your particular needs.
Should You Delay An Auto Purchase?
If you are about to buy a new home it can make sense to delay car purchases until well after closing because the addition of a large monthly debt can sink mortgage applications with marginal DTI ratios.
There are steps you can take if you buy a new car to reduce monthly auto financing costs. For instance, you might get a longer auto loan, say 84 months rather than 60 months.
The catch is that longer loans are very much more expensive than shorter financing. If you borrow $25,000 at 7.5 percent over 60 months, the monthly cost is $501 and the total interest expense is $5,057.
The same loan with an 84-month term has a monthly payment of $383 but a total interest cost of $7,210. If possible, stick with shorter car loans.
In addition, it can make sense to consider the purchase of a newer used car in good condition to cut monthly costs.
According to Experian, the average monthly payment for a used car in the first quarter was $523 versus $735 for a new vehicle. Saving $212 a month is a big deal for most households and will surely please mortgage lenders if you’re financing or refinancing a home.