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Will applying for a car loan affect our credit?

Eva Norlyk Smith Ph.D.

June 2, 2014

QDear Eva,

My wife and I just bought a house, then her car broke down. We probably should get it replaced, but we don't have a lot of cash handy (because of the house). Will lenders reject us for a car loan because we just took on new, big debt? Also, will it hurt our credit ratings to have our credit files pulled so soon after we bought the house? Thanks a lot. –Dorian

AHi Dorian,

Not to worry. It's fairly easy to get approved for a car loan, even if your credit score isn't perfect. At worst, people with a less-than-perfect score end up paying a higher interest rate. Also, even though there may be a small effect on your credit score when you apply for the car loan, it will be minimal and short-lived, as long as you continue paying bills on time and keep credit card balances low.

Regarding your rating, credit rating models are remarkably flexible, and they reflect many situations. So unless your credit is border-line, you shouldn't have any problems getting approved for a car loan. In fact, since you just qualified for a mortgage, presumably your credit is very good, if not excellent. Actually, your credit scores may have improved after you took out the mortgage, because you have shown that you can handle different types of debt.Ask Eva

Lenders use credit scores to determine whether or not a person can be trusted to pay back loans. Most lenders use the FICO scoring model, which factors in payment history, your credit utilization ratio (the amount you owe compared to how much credit you have available), length of credit history, new credit and the types of credit used. You can get your FICO scores for the three major credit bureaus (Experian, Equifax and TransUnion) at MyFico.com for a small fee.

But what you really need to consider is how taking on additional monthly payments will affect your ability to pay other monthly bills, including that new mortgage. To gauge this, it's useful to do the same calculation as banks do, to see what effect car loan payments will have on your debt-to-income ratio.

It can be argued that your debt-to-income ratio is as important as your credit score. It measures how much money you have coming in each month after you have paid off your monthly loan obligations.

The rule of thumb is that the debt-to-income ratio should be below 36 percent.

To calculate  the ratio, add up your monthly debt payments. That includes the mortgage, student loans, other car loans, credit cards, and any other loans you have. Then divide that number by your combined monthly gross income. Use this handy debt-to-income calculator from Bankrate to calculate the ratio.

If your debt-to-income ratio goes over 36 percent when you add the monthly car payment, you may find that you're better off getting a modest loan for a used car.

Moving into a new house usually comes with lots of other expenses, and you don't want to struggle so much to pay monthly bills that you can't enjoy that great new house of yours.

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