How Does Debt Affect Your Ability To Buy A Home?

If you’re preparing to buy a home in the future, you likely have a laundry list of things you need to do to get ready — and that includes getting your finances in tip-top shape.

Aside from double checking your credit score and credit report and making sure you have enough money saved up to purchase in your desired market, you should also consider the ways your current debt balance might affect your ability to buy a home.

Having some debt on your credit report is still really important because lenders need “clues” about how good you are at managing different forms of debt. So having a student loan that you paid off on your credit report can be a green flag to lenders.

Healthy debt management habits can set you up to have an easier time getting approved for your home loan. Not only do you have a history of managing debt, but you also have clues that point to positive management habits — and that can be reflected in your credit score.

Most mortgage lenders look for a credit score of at least 620. Some lenders, like Rocket Mortgage, may still consider applicants who have credit scores of at least 580 for some home loans. But the higher your credit score, the lower your mortgage interest rate will be. That’s why working to improve your credit score before you apply can work to your advantage.

Payment history makes up 35{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} of your credit score. So just by consistently making your credit card, auto loan and other payments every month, you’re contributing to improving your credit score. Likewise, if you were to miss a payment, this could have a big impact on your credit score.

The amount of money you owe is the second most important factor in determining your credit score (it makes up 30{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} of your score). This is usually a measure of your credit utilization, which is the amount of money you owe in relation to your total credit limit. Experts typically recommend keeping your credit utilization below 30{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9}.

So if you have $5,000 as a total credit limit and owe $2,500, your credit utilization is 50{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} and it would be a good idea to continue making payments so you can lower your utilization.

Because of that credit utilization rate, carrying too much debt could drag down your credit score. Coming close to maxing out your available credit makes lenders think that you’re spending beyond your means and would therefore be a risky borrower.

One criteria mortgage lenders assess when reviewing your home loan application is known as the debt-to-income ratio. Your debt-to-income ratio is a comparison of how much you owe to how much money you earn. Your gross income (pre-tax income) is used to measure this number.

According to a breakdown from The Mortgage Reports, a debt-to-income ratio of no more than 43{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} is considered good; a ratio closer to 45{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} might be acceptable depending on the loan you apply for, but a ratio that’s 50{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} or higher can raise some eyebrows.

A higher debt-to-income ratio could make you unable to be approved for some home loan programs with attractive features, like lower down payment minimums. For instance, the HomeReady loan program from Ally Bank requires applicants to have a debt-to-income ratio of no more than 50{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9}, among other criteria.

If you want to calculate your debt-to-income ratio, here’s what you do: Add up all your monthly debt payments, which includes credit card payments, student loan payments and payments to any other lines of credit you may have. Then Divide this number by your gross income amount. The result is your debt-to-income ratio.

If you have an unhealthy amount of debt and are preparing to get a mortgage, consider these strategies to consolidate and pay down your debt.

The debt snowball method is one debt management method where you focus on eliminating the smallest debt balance first while paying just the minimum on all your other debts. On the other hand, the debt avalanche method, involves eliminating your highest-interest debt first. Both methods can be instrumental in helping you crush your debt balance in a more organized way.

This method can potentially help you save on interest since personal loan lenders typically offer much lower interest rates compared to credit card issuers. The Marcus by Goldman Sachs Personal Loan is one of the best debt consolidation loans out there since this lender will send your funds directly to up to 10 creditors.

Balance transfer credit cards with a 0{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} intro APR period are another useful option for getting rid of debt since these credit cards allow you to make interest-free monthly payments for a limited time. Interest charges can eat into your monthly payments and make it feel like your balance is barely going down. With this method, you basically transfer the balance of your current credit card onto a new credit card and you try to pay off the balance before the interest-free period is over.

The Citi® Diamond Preferred® Card gives you 0{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} interest for 21 months on balance transfers (after, 16.74{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} – 26.74{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} variable). So you’ll basically have almost two years to make interest-free credit card payments. Just keep in mind that you’ll have to pay a 5{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} transfer fee on each balance that you transfer.

The Wells Fargo Reflect® Card also offers up to 21 months of 0{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} APR (after, 15.99{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} – 27.99{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} variable). But the balance transfer fee for this card is a little lower at 3{d0229a57248bc83f80dcf53d285ae037b39e8d57980e4e23347103bb2289e3f9} if you transfer within 120 days of account opening.

Having experience managing debt in a healthy manner can help you get approved for a mortgage, but the key here is to make sure you’re practicing positive habits with your debt. Continue making on-time monthly payments toward your debts, don’t let your credit utilization rate get too high and be wary of the amount of debt you have in relation to how much you earn.

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