Does a Car Loan Affect Your Home Loan Borrowing Power?

Yes, a car loan usually reduces how much you can borrow for a home, because lenders treat its repayments as an ongoing commitment that comes out of the income available to service a mortgage. Credit cards and buy now pay later accounts can also reduce your borrowing power, and how each is counted differs between lenders.

This is general information only, not financial, legal or tax advice.

How lenders see your debts

Moneysmart says your borrowing amount depends on your income and financial commitments, your deposit and other savings, and your credit score and credit report. On its loan rejection page it lists having other debts that reduce your capacity to repay as one reason a lender may say no.

Behind that sits the law. ASIC’s Regulatory Guide 209 on responsible lending requires lenders to make reasonable inquiries about your financial situation and to take reasonable steps to verify it. Your existing repayments are part of that picture.

Why a small car loan can have a big effect

It is the monthly repayment that matters, not how the car loan compares in size to the mortgage. A repayment that comes out of your budget for the next few years is a repayment the lender cannot count as available to pay the home loan. And because a home loan runs for up to 30 years and is tested at a higher rate than you will pay, each dollar of monthly commitment removes a large amount of borrowing capacity.

APRA, the prudential regulator, has expected banks to check that new borrowers could still afford repayments at a rate at least 3.0 percentage points above the loan rate, as set out in its October 2021 announcement. That test is what turns a modest monthly repayment into a large reduction in borrowing power.

An illustrative calculation

These figures are my own arithmetic using assumptions, not any lender’s policy. Suppose a car loan has a $400 monthly repayment and a lender tests a 30-year home loan at an assessment rate of 9% a year (a 6% loan rate plus the 3-point buffer).

• Monthly rate: 9% / 12 = 0.75%.
• Repayment per $1 borrowed over 360 months: 0.0075 / (1 – 1.0075^-360), which is about $0.00805. That is roughly $805 a month per $100,000.
• Borrowing capacity lost to a $400 commitment: $400 / 0.00805, which is about $49,700.

So under these assumptions a car loan with a modest balance could cost close to $50,000 of borrowing power. Real lender calculations include other factors, such as living expenses and tax, so treat this as an illustration of the mechanism rather than a prediction.

Credit cards and buy now pay later

In my experience, many lenders assess a credit card on its limit rather than the balance, including cards you do not use. Policies differ between lenders; check with yours. The reason is simple: the limit is what you could borrow tomorrow. Your credit report records this too. Moneysmart says the report includes the credit limit for each credit product held in the last two years.

Buy now pay later is also visible. Moneysmart’s BNPL page says these arrangements can appear on your credit report, that lenders will consider this when you apply for a mortgage, and that many credit checks can be a red flag for lenders. Late or missed payments can lower your score.

Should you pay out the car loan?

It depends. Clearing a loan can lift your borrowing capacity, but it uses cash you may want for the deposit, stamp duty or a buffer. Some lenders do not count a debt that is close to finishing; others do. I would not decide on borrowing power alone. Compare the effect on capacity with what the cash would otherwise do for you, and ask a lender or broker to run both scenarios.

What to do next

• List every debt: car loans, personal loans, credit cards (with limits), BNPL and HECS or HELP if you have it.
• Ask a lender or broker how each is counted, since policies differ.
• Consider lowering or closing credit cards you do not need before applying.
• Avoid new credit applications while you are preparing to apply.
• Ask for borrowing capacity to be modelled with and without the car loan.

Related Reading

• Riverina Property: Why Regional Serviceability Rules Catch Buyers Out
• What Actually Happens to Your Repayments When the RBA Moves
• Home Lending & Property Glossary

Written by Michael Wignall, who’s spent 30+ years in banking and home lending across the ACT, Illawarra, and Riverina regions of NSW.

More on this topic is collected in the Finance Strategies for Australians hub.

Related reading:

• Does HECS Debt Affect Home Loan Borrowing Power?
• Can You Use Gifted Money for a Home Loan Deposit?

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Written by Michael Wignall, Lending Area Manager with 30+ years in banking and home lending across the ACT, Illawarra, and Riverina. Got a question or an idea for a post? Get in touch.