How a personal loan can impact your mortgage application

It’s a smart thing to consider; mortgage lenders typically take a good, hard look at your debt and your recent credit applications as part of determining whether you’re a good candidate for a home loan. But they don’t necessarily view a personal loan as bad news.  

Factors a lender is likely to weigh include when the loan was opened, how much your monthly loan payment is, and crucially, whether you’ve stayed current with your payments. These may impact your maximum borrowing amount for a mortgage, what interest rate you’re offered, etc. Here’s what you need to know about how a personal loan can impact your mortgage application. 

How a personal loan can negatively impact your mortgage application 

Potentially raise debt-to-income ratio 

Your debt-to-income ratio (DTI) is one of the most important factors a lender considers when you apply for a mortgage. Essentially, a lender wants to know that you can handle the monthly payments you’re asking to take on. 

For example, someone with multiple credit card balances and auto loans will likely have a higher DTI ratio than someone with no such obligations who makes the same amount of money. 

Lenders typically prefer a DTI of less than 36%. When you open a personal loan shortly before you apply for a mortgage, you’re adding an additional monthly financial obligation to your plate and likely increasing your DTI ratio—making you a less desirable borrower in the eyes of the financial institution. 

To find your DTI ratio, add up your monthly debt payments and divide that sum by your gross monthly income. Then multiply that number by 100 to get the percentage. 

Temporarily lowers credit score 

When you formally apply for a mortgage, the lender will perform a hard inquiry on your credit profile. With little exception, this causes your credit score to drop by a few points. Nothing devastating—but you’ll want every aspect of your credit in ship shape before you take out a mortgage.  

This means it may be smart to avoid applying for a personal loan when you know you’re going to apply for a mortgage in the near future.  

Potentially result in less favorable mortgage terms 

Even if the above negative impacts produced from opening a personal loan don’t result in a denied application, you may still receive a less advantageous offer from the bank. For example, lenders could offer you lower borrowing amounts and/or higher interest rates. Remember, their best loan terms are saved for those with the least risky profiles. 

How a personal loan can positively impact your mortgage application 

Potentially lower debt-to-income ratio 

While opening a personal loan can increase your DTI, it can also potentially help you to lower it more quickly than if you had not opened it. This happens when you use a personal loan to consolidate debt. by rolling multiple high-interest bills into one loan (ideally with a lower APR), you may be able to pay down debt faster and achieve that desired sub-36% DTI faster. 

Note that this is taking the long view and planning in advance, not a quick fix. 

Lowers credit card utilization 

A personal loan can sharply improve your credit score in as little as a few months with some strategic use, namely, paying down revolving debt such as credit cards. 

One of the weightiest factors of your credit score is the amount you owe on revolving credit lines. For example, if you’ve got a $10,000 credit limit and you have a balance of $5,000, you’re using 50% of your available credit. Experts recommend that you keep your credit utilization below 30% to maintain a good credit score. 

If your credit utilization is high, you may choose to consolidate this debt by opening a personal loan and paying down your credit cards with the funds from the loan. Installment loans don’t count toward your credit utilization—so as far as your credit score is concerned, the credit card debt has been eliminated, and your credit score may soon rise in a noteworthy way. 

Bolster payment history 

Any opportunity you have to exhibit dependable payment history is a boon to your credit profile. Payment history is the single most consequential factor of your credit score. So, reliably making monthly payments after you’ve opened a loan is one of the best things you can do for your credit. 

Improve your credit mix 

Something called “credit mix” accounts for 10% of your FICO Score. What this means is lenders will look at the types of accounts you’ve managed—including revolving accounts like credit cards and retail store cards and also installment accounts like student and auto loans.  

If your only history managing credit is perhaps a credit card or two, your credit might benefit from responsible management of an installment account like a personal loan. 

That said, it’s best to let this evolve naturally. We don’t recommend taking out a loan just to diversify your credit mix.  

Should I avoid opening a personal loan if I want to take out a mortgage? 

As you can see, whether you should open a personal loan before taking out a mortgage is a nuanced matter. Here’s how to decide whether it’s a good idea in your situation. 

When it’s inadvisable to open a personal loan before a mortgage 

Because your credit score will temporarily drop (even if only slightly) after a hard credit inquiry, it’s not ideal to open a personal loan soon before a mortgage. There’s no telling how exactly the decrease will affect the loan terms you’re offered—but a seemingly trivial hike in your APR (even 0.25%) can translate to many thousands of dollars in interest over the life of your loan. 

Additionally, if opening a personal loan will result in a DTI ratio that breaches 36%, opening a personal loan before a mortgage is not a good idea. Even if you can truly afford the mortgage, you shouldn’t give a lender any reason to raise an eyebrow. 

Of course, you shouldn’t open a personal loan before a mortgage if the added monthly payment will put strain on your finances. The last thing you want is stress from multiple long-term loans. 

When it’s okay to open a personal loan before a mortgage 

It’s most likely an okay move to take out a personal loan—as long as you can afford the monthly payment, of course—if you don’t anticipate opening a mortgage in the very near future. 

Loans that are opened months before a mortgage are likely to have less impact on your mortgage application. For example, applying weeks after you’ve opened a personal loan will mean your mortgage will be considered against a credit score that’s likely dropped due to a new credit inquiry. By applying later, you’ll have given your credit score a chance to bounce back (and potentially become higher than before). 

On a similar note, if you can pay off your personal loan before you apply for a mortgage, it could actually be a good thing. The initial DTI increase upon opening a personal loan won’t adversely affect your chances—and you’ll have more positive financial history after you’ve faithfully made every monthly payment. 

The takeaway 

To be on the safe side, prospective homebuyers may wish to avoid new loan applications for at least six months before applying for a mortgage. 

A personal loan can have a meaningful impact on your mortgage application. Depending on how radically it changes your DTI ratio or your credit score, it could be the difference between a mortgage with favorable terms and a flat-out denial. 

That doesn’t necessarily mean you should fear opening a personal loan if you’ve got homebuying aspirations. Just keep in mind that you should do everything in your power to avoid lowering your credit score and increasing your DTI ratio. If you plan ahead in such a way that your personal loan won’t be a weight on those factors, carrying the loan likely won’t make or break your mortgage chances. 

Frequently asked questions