How to Pay Off Debt (if you want to buy a house)
Chances are you have debt, but debt doesn’t mean you can’t buy a home.
77% of Americans have debt.
Credit cards. Student loans. Car payments. HELOCs.
Life is expensive and debt can quickly pile up.
The key is knowing HOW TO PAY OFF DEBT and IN WHAT ORDER.
How to Pay Off Debt (if you want to buy a house)
1. Debt matters when you want to buy a house.
If you get a loan to buy a house, your house payment is added to the monthly payment amounts of other debt you have.
The lender giving you the loan will look at all those monthly payments, and those payments are usually allowed to total about 49% of your gross monthly income. This is called your Debt-to-Income Ratio, or DTI.
For example, if you make $60,000/yr salary ($5,000/mo), you can have about $2,500 in cumulative monthly debt payments.
If you want to buy a house that only costs you $2,000/mo and have no other debt, you will likely be approved.
But, if you also have car payments, credit card debt, and other personal debt that also totals $2,000/mo, your loan application will likely be declined because of the CUMULATIVE total of your monthly debt payments.
2. Not all Debt is Treated the Same
Most buyers with debt have debt that is some combination of:
car payments
credit cards
student loans
child support
other personal debt
Each of those if often calculated uniquely as part of your Debt-to-Income (DTI) Ratio.
3. How to Pay Off Debt in the RIGHT Order (if you want to buy a house)
When you speak with a mortgage banker or broker, they should be able to review your personal finances and offer suggestions on how to pay off debt and in what order.
Usually, that order is:
1. Maintain minimum payments on all debt.
It’s important for building your credit score that you DON’T MISS any monthly payments. Missed payments hurt your score faster than anything. Show yourself to be dependable in paying off your debt.
2. Pay off any and all outstanding Credit Card Debt.
Pay the entire bill each month in order to maintain a $0 balance. If you have a $800 bill at the end of the month, don’t just pay the $57 minimum offered by the credit card company. Pay off all $800. Every month.
If you are unable to pay off the entire outstanding balance, start chipping away at it as aggressively and quickly as possible.
3. Pay off any car loans (a lease is treated differently).
Auto loans have shorter terms (typically 3-7 years) and fixed payments, so once you pay off all credit cards, pay off your auto loans. This can commonly free up $400-$800/mo in monthly debt payment.
$800/mo applied to a house payment is worth about $50,000 in increased home purchase power.
4. Pay off other debts (except student loans).
Do you have any other debt, pay it off here.
Note: As part of your underwriting period (when your finances are reviewed for home purchase loan approval), repeated personal payments to even a friend or family member are often flagged for review and will require explanation.
5. Pay off student loans.
The reason student loans sit at the bottom of the priority stack is because a mortgage lender is only required to count the minimum required payment of your student loans as part of your debt-to-income ratio. This can be as low as 0.5% of the loan balance as a monthly payment.
In other words, even if you pay $400/mo toward your student loans, when in deferment, a lender might not be required to count all of that toward your DTI.
Every person’s situation is unique, so please reach out to learn what a custom plan will look like for you.
If you have a desire to buy or sell in the coming year, let’s chat!
Life has a way of keeping us all moving, and I love to be your real estate agent.
Contact me here to set up your free and confidential consultation.
Kevin
