What can you do about your debt before you buy a home?

Blog posted On February 13, 2020

When you apply for a mortgage, or any other loan or line of credit, your lender will look at your debt-to-income ratio or DTI.  Having debt does not exclude you from buying a home, but most mortgage lenders want your DTI to be 43% or lower to qualify you.    Your DTI is calculated by dividing your monthly debt repayments, like student loans, credit card debt, and car loans, by your gross monthly income. 

So, if your gross monthly income is $5,000 and your monthly debt payments are $2,500 your DTI would be 50%, and too high to qualify for a mortgage.

What can you do about your debt before you buy a home?

Consolidate Loans

Different types of debt have different rates of interest.  Credit cards typically have the highest interest rates compared to federal student loans or car loans.  Debt consolidation is the act of combining different types of debt with a personal loan, so you have one monthly payment, usually at a lower interest rate. 

Taking out a new loan will mean you have a new inquiry on your credit report and may impact your credit score.  Before you consolidate your debt, ask your loan officer if that’s your best option.

Pay Off or Pay Down Some Debt

If you have the means, you may want to pay off some debt before applying for a mortgage.  Generally, financial experts would recommend you start with higher-interest debt like credit card debt.  Closing accounts may impact your credit score because it could change the length of your credit history and limit your credit mix.  Be sure to make any of these major moves six months to one year before applying for a mortgage.

If you’ve been saving for your down payment, your loan officer may recommend shifting some of that savings toward paying down higher-interest debt.  You will have less to put down for your home, but it will lower your debt-to-income ratio.  With numerous low down payment loan options, you may need less for your down payment than you initially thought. 

Credit Repair

Before you start shopping for a home, you should inspect your credit report to make sure it’s accurate.  Credit report errors happen, and some of the debt calculated in your DTI may be from a mistake on your credit report.

All American consumers are entitled to a free annual credit report.  You can request your free credit report here.

Having debt will not make it impossible to qualify for a mortgage, but it may limit your home loan or down payment options.  Lenders want to work with you to help you select the best loan to help you achieve your financial goals.  Let us know if you have concerns about your debt before you apply for a mortgage.

Sources: MarketWatch