Will getting a personal loan affect getting a mortgage?

When you apply for a mortgage, a lender will conduct a comprehensive review of your finances. If you have a loan you’re in the process of repaying, that will be included in the lender’s assessment. In simple terms, getting a personal loan can sway a lender’s decision about whether to offer you the funding you need to buy a home.

Let’s look at how having a personal loan affects getting a home loan and some strategies you can use to offset the negative impacts of a loan when getting approved for a mortgage.

Considerations for getting a loan before buying a house

Personal loans provide the borrower with a lump sum of cash which can be used to consolidate debt or pay other expenses. They are repaid through installments and are often unsecured debt, which means they don’t require collateral. Although flexible, personal loans generally have higher interest rates than secured loans such as mortgages or auto loans.

When you apply for a mortgage, lenders will evaluate your credit history and overall financial profile, including any existing loans or debts and their monthly payments. It is important to assess how taking out a personal loan might impact the key factors outlined below.

Your debt-to-income ratio

One feature of your finances that virtually all mortgage lenders scrutinize is your debt-to-income ratio (DTI), expressed as a percentage and calculated by dividing your monthly debt payments by your gross monthly income.

DTI comes in two forms:

• Front-end DTI: This ratio is calculated by dividing your total housing costs (principal, interest, property taxes, insurance, homeowners’ association fees, etc.) by your monthly income.
• Back-end DTI: This percentage is calculated by dividing all your monthly debt payments by your monthly income.

Taking out a loan will raise your back-end DTI because it’s more debt concerning your income. A higher DTI is worse in the eyes of lenders since they prefer to see a back-end DTI of no more than 36%. Some lenders may allow a higher back-end DTI, depending on the individual circumstances or type of loan.

Your credit score

Besides your DTI, a mortgage lender will evaluate your credit score using a rating system such as the FICO^® Score. This scale was introduced in 1989 and uses several credit factors to calculate your three-digit credit score. Getting a loan affects your credit score in the following ways:

• Payment history: A personal loan may impact your credit score depending on your repayments. If you make late payments or miss some altogether, your credit score will likely decrease, causing potential lenders to see you as a risky borrower. However, if you make your payments on time, your credit score could possibly increase if the rest of your credit profile is also good.
• Credit mix: Your loan can also affect your credit mix, which is the different types of credit accounts you hold. For instance, if you only have revolving debt, such as a credit card, getting a personal loan – a form of installment debt – could diversify your forms of credit and increase your credit score.
• New credit: New credit accounts are another factor influencing your FICO® Score. That’s because each time you apply for new credit, the lender will make a hard inquiry that could temporarily drop your credit score.

The clear advantage here is that a loan – specifically, one you’ve already paid off – could be a net positive on your credit score if you made on-time payments and it diversified your credit mix. However, it will be a net negative if you are late to pay or miss payments.

Should you pay off your personal loan before applying for a mortgage?

If you can afford it, paying off your loan before applying for a mortgage will likely increase your chances of approval for a few reasons.

First, clearing an active loan from your credit report will improve your credit score. But, more importantly, removing this monthly debt payment will lower your back-end DTI. This change could help you get approved for a home loan and secure a better interest rate from a lender.

It’s also better to pay off your personal loan before starting to repay your home loan for several other reasons, such as having one less bill to worry about and the ability to replenish your savings after your down payment and closing costs.

Tips for improving your chances of mortgage approval

Enhancing your credit score and financial situation is crucial when applying for a home loan. The more responsible the lender perceives you as a borrower, the easier it will be to obtain approval. Consider taking the following actions:

• Paying off or consolidating debts
• Building up your emergency fund
• Checking your credit report for incorrect information
• Asking the credit bureaus to remove any outdated, negative entries from your report
• Making on-time payments

It’s also best to avoid doing anything to negatively affect your credit score while applying for a home loan. Actions to avoid include:

• Applying for new credit cards
• Applying for any new loans
• Changing jobs, quitting your job, starting a new business, or doing anything that would affect your employment history
• Missing any payments on your current debts
• Depleting your savings accounts
• Increasing your credit card debt

FAQs: Getting a personal loan before buying a house

Use the answers to these frequently asked questions to learn more about how a personal loan might affect your mortgage application.

Can a personal loan prevent me from getting a mortgage?

Yes, a personal loan can prevent you from getting a mortgage. A loan will impact your credit score and your debt-to-income ratio (DTI). You'll be denied a mortgage if those factors fall below lender thresholds.

Alternatively, a loan that you’ve successfully paid back can positively impact your application if it improves your credit score and your debt-to-income ratio now falls within an acceptable range for the lender.

Can I use a personal loan for my home down payment?

Taking out a loan for a down payment isn’t recommended, and most lenders will reject your application if you need to do this. You’re probably better off saving up more for the down payment, even if it means putting the house hunt on hold.

Does having a car loan affect buying a house?

Yes, an active car loan will affect your mortgage application in the same way an active personal loan will by raising your debt-to-income ratio (DTI). A higher DTI hurts your chances of loan approval.

Does a personal loan affect my credit score?

Yes, a personal loan will affect your credit score. If you’re regularly making on-time monthly payments, that will have a positive impact on your credit score. But your credit score will likely suffer if you’re missing monthly payments or your current balance isn’t much lower than the original balance.

Can I use a personal loan instead of a mortgage?

Since personal loans have lower loan amount limits than mortgages, it will likely be hard to cover the entire home purchase with this type of financing. You also probably won’t be able to use a personal loan for your down payment since most lenders prohibit this practice. However, you may be able to use a loan to fund an alternative to traditional housing, perhaps in the form of an RV or a tiny house.

Final thoughts

While applying for a personal loan can impact your ability to secure a mortgage, this doesn’t necessarily mean you won’t be able to buy a home. It might just require more effort to ensure on-time payments and reduce your overall debt-to-income ratio. In most cases, however, it’s better to pay off a loan before you apply for a mortgage.

If you do want a personal loan before you start the home-buying process, you can prequalify with Rocket Loans^SM today.