Stop! Don’t Purchase that Car

You have found a great job. You are finally making some money and even have a little extra to set aside in savings. What are you going to do with this increasing wealth? If you are like most North Americans with some money to spend, you will begin to think about buying a new car. Maybe even a house!

But since home ownership always presents itself as a distant and promising dream, buying a car is much less daunting. Don’t do it! Let me tell you what will happen. You have found that dream home and you contact your lender to get the pre-qualification letter that the seller is expecting. As part of your interview with the lender, you let him know how much you think you can afford. After asking you about your salary, your savings and your debts he works through the numbers. Then it happens…he says “Well, you certainly would have qualified for this home if only you didn’t have this car payment.”

Your Debt-to-Income Ratio is the Key

The lender determines whether or not you qualify for a mortgage by looking at your “debt-to-income” ratio. This is the percentage of your gross monthly income that you spend on debt. That debt is composed of items such as your monthly housing costs, credit card debt, student loans you may still be paying off, and…your monthly car payment.

How Does Having a New Car Payment Reduce Your Purchase Price?

Let’s assume that current interest rates run at 8% on a 30 year fixed rate loan. Suppose your monthly income is $5000 and your car payment is $400. By having that car payment, you qualify for about $55,000 less in loan value. Remember, the mortgage companies approve you based on their guidelines, not whether you think you can afford that car payment. However, don’t get disheartened, you should still get pre-qualified by a lender before buying a home.

Look to the Future

So remember, think of buying a home before buying that shiny new car. Purchasing a home will contribute much more to your future financial well being. You can always get that new car next year.

The Business Cycle and Buying a Home