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.

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1) It shows lenders you can handle paying back lenders

2) Managing debt well can improve your credit score

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.

Rocket Mortgage

  • Annual Percentage Rate (APR)

    Apply online for personalized rates

  • Types of loans

    Conventional loans, FHA loans, VA loans and Jumbo loans

  • Terms

    8 – 29 years, including 15-year and 30-year terms

  • Credit needed

    Typically requires a 620 credit score but will consider applicants with a 580 credit score as long as other eligibility criteria are met

  • Minimum down payment

    3.5% if moving forward with an FHA loan

Payment history makes up 35% 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% 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%.

So if you have $5,000 as a total credit limit and owe $2,500, your credit utilization is 50% 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.

3) Having too much debt can make you ineligible for some home loans

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.

A lower debt-to-income ratio suggests that you have a healthy balance between debt and income. However, a higher debt-to-income ratio suggests that too much of your income is going toward paying down debt, and this will make a mortgage lender see you as a risky borrower.

According to a breakdown from The Mortgage Reports, a debt-to-income ratio of no more than 43% is considered good; a ratio closer to 45% might be acceptable depending on the loan you apply for, but a ratio that’s 50% 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%, among other criteria.

Ally Bank

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included

  • Types of loans

    Conventional loans, HomeReady loan and Jumbo loans

  • Terms

  • Credit needed

  • Minimum down payment

    3% if moving forward with a HomeReady loan

Pros

  • Ally HomeReady loan allows for a slightly smaller downpayment at 3%
  • Pre-approval in just three minutes
  • Application submission in as little as 15 minutes
  • Online support available
  • Existing Ally customers can receive a discount that gets applied to closing costs
  • Doesn’t charge lender fees

Cons

  • Doesn’t offer FHA loans, USDA loans, VA loans or HELOCs
  • Mortgage loans are not available in Hawaii, Nevada, New Hampshire, or New York

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.

How to consolidate and best payoff debt

Marcus by Goldman Sachs Personal Loans

  • Annual Percentage Rate (APR)

    6.99% to 24.99% APR when you sign up for autopay

  • Loan purpose

    Debt consolidation, home improvement, wedding, moving and relocation or vacation

  • Loan amounts

  • Terms

  • Credit needed

  • Origination fee

  • Early payoff penalty

  • Late fee

Balance transfer credit cards with a 0% 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% interest for 21 months on balance transfers (after, 16.74% – 26.74% 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% transfer fee on each balance that you transfer.

Citi® Diamond Preferred® Card

  • Rewards

  • Welcome bonus

  • Annual fee

  • Intro APR

    0% for 21 months on balance transfers; 0% for 12 months on purchases

  • Regular APR

  • Balance transfer fee

    5% of each balance transfer; $5 minimum. Balance transfers must be completed within 4 months of account opening.

  • Foreign transaction fee

  • Credit needed

Pros

  • No annual fee
  • Balances can be transferred within 4 months from account opening
  • One of the longest intro periods for balance transfers

Cons

  • 3% foreign transaction fee

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

Wells Fargo Reflect® Card

On Wells Fargo’s secure site

  • Rewards

  • Welcome bonus

  • Annual fee

  • Intro APR

    0% intro APR for 18 months from account opening on purchases and qualifying balance transfers. Intro APR extension for 3 months with on-time minimum payments during the intro period. 15.99% – 27.99% variable APR thereafter; balance transfers made within 120 days qualify for the intro rate

  • Regular APR

    15.99% – 27.99% variable APR on purchases and balance transfers

  • Balance transfer fee

    Introductory fee of 3% ($5 minimum) for 120 days from account opening, then up to 5% ($5 minimum)

  • Foreign transaction fee

  • Credit needed

Pros

  • No annual fee
  • Long introductory APR period up to 21 months on purchases and qualifying balance transfers
  • 3% intro balance transfer fee ($5 minimum) for first 120 days
  • Access to Visa Signature Concierge
  • Get up to $600 cell phone protection
  • Access to My Wells Fargo Deals to earn cash back in the form of a statement credit when shopping, dining

Cons

  • No rewards
  • No welcome bonus
  • 3% fee charged on foreign transactions

Bottom line

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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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.