What Is Car Finance?

Car finance is a popular way to buy a car because rather than paying the full cost of the car upfront, you pay for it in monthly instalments. This allows you to spread the cost of the car over a longer period, making it more affordable for many people. As long as you have a GAP insurance policy in place, you’ll also be covered to the full price so that you aren’t left out of pocket if the car is written off or stolen.

There are several types of car finance to choose such as hire purchase (HP), personal contract purchase (PCP) and personal leasing.

Using HP as a method of financing a car means that you pay a deposit and then make monthly payments over a set period, typically between 12 and 60 months. Once you reach the end of the contract, you’ll own the car.

With PCP, you pay a deposit and make monthly payments over a set period, usually between 12 and 48 months. At the end of the agreement, you’ll have the option to either hand the car back or pay a final payment to own it outright.

Finally, with personal leasing, you essentially rent the car for a set period, typically between 12 and 48 months.

As you can probably imagine, as a leading mortgage broker in the area, we get asked about car finance a lot and below is everything you need to know regarding whether it affects your mortgage application.

How Does Car Finance Affect Your Mortgage Application?

When you apply for a mortgage, lenders will look at your income and outgoings to determine whether you can afford to make the repayments on the mortgage. If you have a car on finance, that’ll be taken into account when calculating your outgoings.

The amount you pay each month for your car finance will be included in your monthly outgoings. This means that if you have a large car finance payment each month, this will reduce the amount of money you have available to put towards your mortgage payments. As a result, it could affect your ability to secure a mortgage or the amount you can borrow.

The Impact of Car Finance on Affordability

To understand the impact of car finance on your affordability for a mortgage, let’s consider an example.

Let’s say that you earn £40,000 per year and have a car on finance that costs you £200 per month. If you apply for a mortgage, a lender may consider your outgoings to be as follows:

• Monthly mortgage payment: £750
• Car finance payment: £200
• Other outgoings (e.g. bills, food, etc.): £500

In this example, your total outgoings would be £1,450 per month. If you were to apply for a mortgage, the lender would want to ensure that you could afford the monthly repayments on the mortgage without being stretched too thin.

In this case, they may consider your maximum affordability to be around £1,000 per month.

If your mortgage repayments are likely to be higher than £1,000 per month, you may struggle to secure a mortgage, even if you meet all of the other affordability criteria. This is because the lender will consider your outgoings to be too high and therefore, you may struggle to make the repayments on the mortgage.

The Impact of Car Finance on Credit Score

Another factor to consider is car finance’s impact on your credit score. Your credit score is an important factor that lenders will look at when deciding whether to approve your mortgage application. If you have a car in finance, this can affect your credit score in several ways.

Firstly, when you take out car finance, the lender will perform a credit check. This will leave a mark on your credit file that can potentially lower your credit score, which makes it more difficult to secure a mortgage or other types of credit.

In addition, having car finance can affect your credit utilization, which is another important factor that affects your credit score. Credit utilization is the amount of credit you use compared to the amount you have available. For example, if you have a credit card with a limit of £5,000 and you have a balance of £2,500, your credit utilization would be 50%.

If you have car finance, the amount you owe will be added to your total credit utilization. This means that if you have a high car finance balance, it could increase your credit utilization and lower your credit score. This could also affect your ability to secure a mortgage because lenders will view you as having a higher credit risk.

It’s important to note that having car finance is not necessarily a bad thing for your credit score. If you make all of your car finance payments on time, that’ll have a positive impact on your credit score because it shows that you are a responsible borrower. However, if you miss payments or default on your car finance, this will have a negative impact on your credit score and could make it more difficult to secure a mortgage.

How to Improve Your Chances of Getting a Mortgage with Car Finance

If you have car finance and are looking to secure a mortgage, below are some tips to improve your chances of getting approved.

1. Pay Off Your Car Finance

If possible, try to pay off your car finance before you apply for a mortgage. This will reduce your outgoings and improve your affordability, which will make it more likely that you will be approved for a mortgage.

2. Reduce Your Car Finance Payments

If you can’t pay off your car finance, try to reduce your monthly payments by extending the term of the agreement. This will reduce your monthly outgoings and improve your affordability.

3. Improve Your Credit Score

Improving your credit score is one of the best ways to improve your chances of getting a mortgage. You can improve your credit score by making all of your car finance payments on time, paying off any outstanding debts and checking your credit report for errors.

4. Consider A Smaller Mortgage

It may be more difficult to secure a large mortgage if you have a large car finance payment each month. Consider applying for a smaller mortgage or saving up a larger deposit to reduce the size of the mortgage.

5. Sell The Car

If the finance you have remaining on your car is affecting your ability to secure a mortgage, you may want to consider selling it. To do this, you can either trade it into a dealer or even sell your car privately for more money.

Conclusion

To conclude, having a car on finance can affect your chances of getting a mortgage. Therefore, when you apply for a mortgage, the lender will consider your outgoings, including your car finance payments, to determine whether you can afford the monthly repayments on the mortgage. Additionally, having car finance can also affect your credit score, which is another important factor that lenders consider when deciding whether to approve your application.

However, having car finance is not necessarily a bad thing for your mortgage application. If you manage your car finance well and make all of your payments on time, this can have a positive impact on your credit score and improve your chances of getting approved for a mortgage. If you have car finance and are looking to secure a mortgage, it’s important to consider all of the factors involved and take steps to improve your affordability and credit score.