When you apply for a mortgage, any outstanding debts you have — including personal loans, credit cards, and auto loans — can impact how much of a mortgage you can get, and whether you even qualify in the first place.
If you’re planning to buy a home within the next couple of years, applying for a personal loan could potentially reduce how much you can borrow. A personal loan can also affect your credit — this impact could be positive or negative depending on how you manage the loan.
Whether you’re thinking about getting a personal loan or currently paying one off, here’s what you need to know about how personal loans interact with mortgages.
Key Points
• A personal loan can have a negative or positive effect on your chances of getting approved for a mortgage.
• Personal loans affect debt-to-income ratio, which can influence mortgage approval and borrowing limits.
• If handled responsibly, a personal loan can have a positive impact on your credit profile.
• New credit inquiries from personal loans can temporarily lower credit scores.
• A diverse credit mix, including personal loans, can enhance your credit file.
How Do Personal Loans Work?
A personal loan is a lump sum of money borrowed from a bank, credit union, or online lender that you pay back in fixed monthly payments, or installments. Unlike mortgages and auto loans, personal loans are typically unsecured, meaning there’s no collateral (an asset that a borrower pledges as security for a loan) required.
Lenders typically offer loans from $1,000 to $50,000, and this money can be used for virtually any purpose. Common uses for personal loans include:
• Debt consolidation
• Home improvement projects
• Emergencies
• Medical bills
• Refinancing an existing loan
• Weddings
• Vacations
Personal loans usually have fixed interest rates, so the monthly payment is the same for the term of the loan, which can range from two to seven years. On-time loan payments can help build your credit file, but missed payments can hurt it.
Can Personal Loans Affect Mortgage Applications?
Yes, getting a personal loan could impact a future mortgage application. When you apply for a home mortgage loan, the lender will look at your full financial picture. That picture includes your credit history (how well you’ve managed debt in the past), how much debt you currently have (including personal loans, credit cards, and other debt), your income, and credit score.
Depending on your financial situation, getting a personal before you buy a house could have a positive or negative impact on a mortgage application. Here’s a closer look.
Negative Effects
A personal loan could have a negative impact on your mortgage application if the loan payments are high in relation to your income. A lender may worry that you don’t have enough wiggle room to cover your current expenses and debts, plus a mortgage payment.
Another potential drawback is the impact on your credit score, especially if the loan is recent. When you apply for a personal loan, it triggers a hard inquiry on your credit report, which can temporarily lower your score. In addition, any missed or late payments on your personal loan impact your payment history, which is a significant factor in your credit score.
Recommended: Using a Personal Loan for a Down Payment
Positive Effects
If you have a personal loan that is a reasonable size (relative to your income), your personal loan payment history shows that you regularly pay on time, and you’re consistently paying down any other debts, a mortgage lender could see that as a positive indicator that you’d likely be a low-risk investment.
What’s more, a personal loan adds variety to your credit mix — the types of credit you use. A balanced credit portfolio that includes both revolving credit (like credit cards) and installment credit (like personal loans) may help strengthen your credit profile.
How Personal Loans Can Affect Getting a Mortgage
Here’s a closer look at the ways in which getting a personal loan can affect your ability to get a home mortgage.
Credit Score
Your credit score is one indication to a lender of how likely you are to be to repay a loan — or, in other words, how much risk you represent to the lender. A personal loan can affect your credit score in several different ways. These include:
Payment History
Your bill-paying track record is typically the most significant factor in your credit scores, accounting for approximately 35% of your FICO® Score. On-time payments on a personal loan demonstrate financial responsibility and help build a positive payment history. Over time, this consistency can have a favorable impact on your credit file. On the flip side, missed or late payments can negatively affect your credit profile and damage your chances of mortgage approval.
New Credit
When you apply for a personal loan, the lender will run a hard credit inquiry. This type of credit check can cause a small, temporary drop in your scores. In addition, a new loan reduces the average age of your credit accounts, which may further impact your credit file, especially if your credit history is limited.
Credit Mix
Credit mix accounts for about 10% of your FICO credit score. Lenders like to see that you can manage various types of credit responsibly. If you only have credit cards, adding an installment loan like a personal loan could positively impact your credit file and make you look more attractive to a mortgage lender.
Credit Utilization
If you use a personal loan to consolidate and pay off high-interest credit card debt, it could favorably impact your credit by lowering your credit utilization ratio.
Your credit utilization ratio is the percentage of available credit that you’re currently using on your credit cards and other lines of credit, and is another important factor in your credit scores. Keeping your utilization below 30% is generally recommended for maintaining good credit health.
Recommended: Personal Loan Calculator
Debt-to-Income Ratio
Your debt-to-income (DTI) ratio refers to the total amount of debt you carry each month compared to your total monthly income. Your DTI ratio doesn’t directly impact your credit score, but it’s an additional factor lenders may consider when deciding whether to approve you for a new credit account, such as a mortgage. Having a personal loan will increase your debt load and, in turn, your DTI ratio.
To calculate your DTI ratio, add up all your monthly debt payments and divide them by your gross monthly income (that’s your income before taxes and other deductions are taken out). Next, convert your DTI ratio from a decimal to a percentage by multiplying it by 100.
The DTI ratio you need to secure a mortgage varies by lender. Generally, though, mortgage lenders prefer a DTI ratio of 36% or below.
Should You Pay Off Your Personal Loan Before Applying for a Mortgage?
If you already have a personal loan, are close to the end of your repayment term, and can afford to pay off the remainder before applying, eliminating the debt could improve your chances of getting the mortgage amount you’re looking for.
Another reason why you may want to pay off your personal loan before buying a home is that home ownership generally comes with a lot of additional expenses. Not having a personal loan payment to make each month can free up cash you may need for other things, like mortgage payments, homeowners insurance, and more.
That said, if paying off a personal loan will use up money you had earmarked for a downpayment on a home or leave you cash poor (with no emergency fund), it might be better to keep making your monthly payments, rather than pay off your personal loan early.
Tips to Help Your Mortgage Application
Generally speaking, having a personal loan won’t make or break your odds of getting a mortgage. If you’re concerned about being approved, however, here are some steps that can help.
Avoid Taking on New Debt Before Applying
It’s wise to avoid taking any type of new debt in the months before applying for a mortgage. New debt can increase your DTI and also cause a temporary drop in scores due to the recent hard inquiry. It also signals to lenders that you may be relying on credit to make ends meet, which can raise concerns about your financial stability.
Check Your Credit Report for Errors
Before you submit a mortgage application, it’s a good idea to review your credit reports to make sure there are no errors or inaccuracies. Mistakes like incorrect balances, outdated accounts, or erroneous late payments can hurt your chances of approval.
You’re entitled to a free credit report every week from each of the three major credit bureaus — Equifax®, Experian®, and TransUnion® — at AnnualCreditReport.com. If you find any mistakes, you can dispute them with the appropriate bureau.
Consider Getting Prequalified
Getting prequalified for a mortgage gives you an idea of how much you may be able to borrow based on your income, credit, and debts. It’s not a guarantee of loan approval, but it can help you identify any red flags in your financial profile — such as a high DTI or low credit score — before formally applying.
Prequalification also helps you set realistic expectations when house hunting and shows sellers you’re a serious buyer.
The Takeaway
A personal loan can impact your ability to get a mortgage, but the effects depend on how you manage the loan and your overall financial situation. Personal loans can increase your debt burden and negatively affect your credit file if mismanaged. But they can also help build credit and demonstrate responsible borrowing when used wisely.
If you’re not planning to apply for a mortgage right away, and can comfortably manage the personal loan payments (and possibly even pay off the loan early), getting a personal loan could help you build credit and make it easier to get a mortgage.
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.
FAQ
Can a personal loan hurt your chances of getting a mortgage?
A personal loan could potentially hurt your chances of getting a mortgage. A personal loan increases your monthly debt obligations, which could reduce the amount you’re approved to borrow. Also, If you struggle to make timely payments on the personal loan, it will negatively impact your payment history, which is a key component of your credit score.
That said, having a personal loan and managing it responsibility could be a net positive if it adds to your positive payment history and diversifies your credit mix. This could improve your chances of getting a mortgage.
Should you close a personal loan before applying for a mortgage?
Closing (or paying off) a personal loan before applying for a mortgage can be beneficial, especially if it lowers your debt-to-income (DTI) ratio. A lower DTI can improve your mortgage eligibility and may help you qualify for better interest rates. However, it’s important to weigh this decision carefully. If paying off the personal loan significantly depletes your savings and limits your ability to make a substantial down payment, it might be more strategic to continue making regular payments.
How much does a personal loan impact debt-to-income ratio?
A personal loan directly affects your debt-to-income (DTI) ratio because its monthly payment is included in your total monthly debt obligations. Lenders calculate DTI by dividing total monthly debt by gross monthly income. Even a relatively small personal loan can increase your DTI enough to impact your mortgage eligibility. Keeping your DTI below 36% is generally recommended for mortgage approval.
Is it easier to get a mortgage without other active loans?
Yes, having no other active loans can make it easier to qualify for a mortgage. Without additional debt, your debt-to-income (DTI) ratio will be lower, making you appear less risky to lenders. A low DTI may also allow you to qualify for a larger loan amount or better interest rates. However, having a mix of well-managed credit can also be favorable. The key is maintaining a healthy balance — manageable debt, on-time payments, and a strong credit score.
Do mortgage lenders consider personal loans as part of your liabilities?
Yes, mortgage lenders include personal loans when calculating your total liabilities. These liabilities help determine your debt-to-income (DTI) ratio, a key factor in mortgage approval. Lenders will look at your credit report to verify outstanding balances and monthly payment obligations, including personal loans. Even if the loan has a low balance, the monthly payment counts toward your DTI. Keeping loan payments manageable and your overall DTI low can improve your chances of mortgage approval.
Photo credit: iStock/kate_sept2004
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