Will Getting A Personal Loan Affect Getting A Mortgage?

A lot goes into applying for a mortgage. Your lender will conduct a comprehensive review of your finances, and if you have a personal 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 absolutely sway a lender’s decision about whether to offer you the funding you need to buy a home.

Let’s look at some ways that having a loan affects getting a mortgage, and we’ll also explore some strategies you can use to offset the influence of a personal loan on a mortgage determination.

To get a mortgage, you’ll need to meet specific criteria your lender uses for approval. Your credit history and the loans you’ve used or are currently using can affect your overall financial profile and how a lender views it. Before applying for a mortgage, consider how your personal loan could impact the aspects of your finances discussed next.

Your Debt-To-Income Ratio

One feature of a loan applicant’s finances that virtually all mortgage lenders scrutinize is the applicant’s debt-to-income ratio (DTI), which is 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 personal loan will impact your back-end DTI because it’s more debt in relation to your income, which will raise your DTI. A higher DTI is worse in the eyes of lenders, as many prefer to see a back-end DTI of no more than 36%.

Your Credit Score

Besides your DTI, a mortgage lender will evaluate your credit score and do so 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 personal loan affects the following factors that all influence your credit score:

• Payment history: The biggest factor in your credit score that your personal loan will impact is your payment history. If you make late payments or miss some altogether on your personal loan, your credit score will likely decrease and potential lenders could see you as a risky borrower.
• Credit mix: Your personal 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, getting a personal loan – a form of installment debt – could diversify your credit mix and actually increase your credit score.
• New credit: Another factor that influences your FICO^® Score is new credit accounts. 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 upshot here is that a personal 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, if you were late to pay or missed payments, it will be a net negative.

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

First, clearing an active personal loan from your credit report will help improve your credit score. But, more importantly, removing this monthly debt payment will lower your back-end DTI. This change could help you not only get approved for a home loan but also secure a better interest rate from a lender.

Other benefits follow after approval. For example, owning a home means incurring a lot of extra costs, so having one less bill to worry about can improve your peace of mind. You can also start to replenish the savings you may have depleted with your down payment and closing costs.

Before applying for a mortgage, a borrower must realize that some actions are simply a bad idea, and they should abstain accordingly. It’s always best to avoid doing anything that negatively affects your credit while you’re in the process of buying a new home.

Actions to avoid include:

• Applying for new credit cards
• Applying for any new loans
• Changing jobs or anything that would affect your employment history
• Missing any payments on your current debts
• Depleting your existing savings accounts or drastically increasing your credit card debt

Instead of doing any of the above, focus on making changes that can improve your credit score and financial standing.

Actions to consider taking include:

• 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

Proceeding with any of these steps can improve your credit score while making you look like a more responsible borrower. The more lenders view you as a responsible borrower, the easier it will be to secure a mortgage.

Use the answers to these frequently asked questions to learn more about how personal loans and mortgages can mix.

Can a personal loan prevent me from getting a mortgage?

Yes, a personal loan can prevent you from getting a mortgage – indirectly. A personal loan will impact your credit score and your DTI. If those factors fall below lender thresholds, you’ll be denied a mortgage.

Alternatively, a personal loan that you’ve successfully paid back can positively impact your application if it improved your credit score and your DTI 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 that’s especially true for a personal loan. 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 DTI. A higher DTI hurts your chances of loan approval.

Does a personal loan affect my credit score?

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

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 purchase of a home 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 personal loan to fund an alternative to traditional housing, perhaps in the form of an RV or a tiny house.

While using a personal loan that remains active 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. Or, then again, it might require paying off your loan early to lower your DTI. In most cases, though, it’s better to pay off a personal loan before you apply for a mortgage.

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