It almost seems impossible to live without credit cards, student loans, car payments, and all sorts of debts. The average American carries around $38,000 in personal debts and the number of debt-free American adults is presently fewer than one in four.
What does this mean when buying a home? It means it’s time to rethink waiting to buy a home until you’re completely free of all financial obligations. There are new homebuyers everyday who have credit card bills and student loan payments. Again, you DO NOT need to be completely debt-free to qualify for a mortgage. However, you should understand how debts can impact your ability to qualify for a loan.
You should never assume that having debt is an automatic indication that your finances are in bad shape. With mortgages, lenders assess a borrower’s finances in part on their debt-income ratio (DTI). This ratio is used to determine the percentage of your monthly income that needs to be allocated to pay off any existing financial obligations.
For example, let’s assume your gross monthly income is $7,000 a month. Your car payment is $400 a month. Student loans are $350 and the monthly minimum payments for your credit cards add up to $250.
$400 + $350 + $250 = $1,000 in monthly payments.
$1,000 in debt payments / $7,000 income = a DTI ratio of 14.2%
In most cases, lenders want to work with borrowers who have a DTI of less than 43%. This is after your mortgage has been included. Keep in mind that your DTI will need to be lower under 2 conditions: (1) lower credit score; (2) very little savings.
In this scenario, the maximum mortgage payment you can have to stay under the 43% threshold would be about $2,010.
Now, whether that’s enough for a mortgage payment on your dream home is going to depend on your down payment and the median house price of the location you’d like to live in. Always remember that as you bring debts down, the mortgage you qualify for goes up.
In this example, paying off your car note can potentially increase your mortgage amount to $2,410 a month.
Lowering Your Monthly Debt Obligations
Remember that DTI is solely concerned with your monthly debt payments. If a high DTI is keeping you from owning a home, it’s time to consider lowering the required monthly payments on your debts. This does not mean you have to lower your overall debt (although that would be great). Instead, you can elect to use a personal debt consolidation loan to lower the monthly payment on your credit card debt. Keep in mind that many debt consolidation loans come with lower interest rates than credit cards. Nevertheless, you should still read the fine print.
As for student loans, check and see if your loan service offers extended or income-contingent repayment plans. A different repayment plan can lower your monthly payment obligation and improve your DTI ratio. Loan consolidation with a new servicer is also a feasible option. Many offer lower interest rates and lower monthly payments, but again, read the fine print.
Think you’re ready to get started or want to know where you stand? Get pre-qualified for a mortgage in a matter of minutes by clicking here.