Why You Shouldn't Buy A New Car Right Before You Buy A House
When a person's income starts to grow and they manage to set aside some savings, they commonly experience what may be considered an innate instinct of modern civilized mankind: The desire to spend money. Since North Americans have a special love affair with the automobile, this becomes a high priority item on the shopping list. Later, other things will be added and one of those will probably be a house.
However, by the time homeownership has become more than a distant and hopeful dream, you may have already bought the car. It happens all the time, sometimes just before you contact a lender to get pre-qualified for a mortgage.
As part of the interview, you may tell the lender your price target for a home. He will ask about your income, your savings and your debts, then give you his opinion.
"If only you didn't have this car payment," he might begin, "you would certainly qualify for a home loan to buy that house or condo." You see, when determining your ability to qualify for a mortgage, a lender looks at two "debt-to-income" ratios....the GDS (gross debt service) and the TDS (total debt service)
What are GDS and TDS?
GDS and TDS ratios are the percentages of your gross monthly income (before taxes) that you spend on debt. GDS will include your monthly housing costs including principal, interest, taxes and 50% of your heating or condo fees divided by your gross monthly income. The maximum allowed is 32%
TDS will also include your monthly consumer debt, including credit cards, student loans, installment debt, and car payments and again divide that sum by your gross monthly income to calculate the ratio. The maximum allowed is 40%.
How a New Car Payment Reduces Your Purchase Price
Suppose you earn $5000 a month and you have a car payment of $400. At current interest rates (let's say 6% for a five-year fixed rate mortgage), you would potentially qualify for approximately $66,000 less of a mortgage than if you did not have the car payment (subject to what other debts you did have). Even if you feel you can afford the car payment, mortgage lenders approve your mortgage based on their guidelines, not yours.
Buying things on credit not only hurts your credit score, but it also leaves less money for you to use for a house payment. Lenders look at this figure also to determine how much money they will lend you, and how much they will charge you to lend it. If you haven't already bought a new car, remember one thing... think ahead. Think about buying a home first. Buying a home is a much more important purchase when considering your future financial well being.