When you begin looking for a home loan, you will quickly discover one thing, debt is a huge deal. Carrying debt drags down your credit score and will throw off your debt-to-income ratio. Both of these things can keep you from qualifying for the home of your dreams.
If you find that debt is standing between you and your home, here are some ways to conquer it.
Consolidate Your Debt
No, debt consolidation will not improve your debt-to-income ratio, but it can decrease your credit utilization. Credit utilization is the second biggest factor that dictates your credit score. Simply put, it is how much of your credit that you are using. If you have $1000 in credit and are using $500 of it, your credit utilization is 50 percent. To have good credit utilization, you need to be using under 30 percent of what’s available. To be in the excellent category, it needs to be under 10 percent.
The best way to get a consolidation loan would be to work with a local credit union, but if your credit cards are maxed, you may not be able to qualify with a local bank. An alternative is to use an online loan website like LoanMonkey.net to help you find a lender that will approve you.
Once you have your loan, you can pay down your credit cards and you should see a credit score increase as soon as these creditors report to the bureaus. It should take about two months for this to happen, but if you intend to buy a home, try to get your consolidation loan at least six months before you apply for a mortgage. This will give your credit time to settle.
Pay Down Your Credit Cards
If you cannot qualify for a decent debt consolidation loan, you will need to do things the old-fashioned way. You need to pay down that debt dollar by dollar. The best way to do that is to use a debt reduction method.
The most popular of these methods is the Debt Snowball Method. With this method, you pay the minimum payment on all your cards except the one with the lowest balance. On this card, you pay as much as you can until it is paid off. Once the card is paid off, you switch to the next lowest balance, then rinse and repeat. The idea with this method is motivation. You work on the lowest balance cards first so that you get the victory of a paid in full card quicker. This motivates you to carry on.
Another popular method is the Debt Avalanche Method. If you like logic, this is the best choice. This method involves paying the minimum on all the cards in your wallet except the one with the highest interest rate. On this card, you pay as much as you can until it is paid off and then move on to the next highest interest card. The idea here is that you get the most bang for your buck. Paying off the highest interest debt first will save you money.
Increase Your Limits
Once again, this will not improve your debt-to-income ratio, but it will decrease your credit utilization. Simply call your credit card companies and ask for a credit line increase.
Increasing your limit on a card works just as well as paying down the debt when it comes to credit utilization. If you have a credit card with a limit of $1000 and are using $500, your utilization is at 50 percent. Get a credit line increase to $2000 and your $500 balance now means that you are at 25 percent utilization.
Increasing your limits by working with existing creditors is much better than opening new accounts. Opening new accounts will lower your utilization, but it will also count as an inquiry and will lower your average account age. Two things that can lower your credit score. In addition, existing creditors will usually do a soft credit pull which will not show up on your report.
Divert Down Payment Money
A large down payment is a great thing, but sometimes it might be better to divert some of that money towards your debt.
When people save for a home, they often put their revolving debt on the back burner, trying to put as much money in their savings account as possible. This is great, up until the point where you have enough money for a down payment.
If you are going with an FHA loan, for example, you need 3.5 percent down. Saving enough money to put down 10 percent can lower your mortgage insurance and allow for the mortgage insurance to eventually drop off, but the money may be better used elsewhere.
Once you have a minimum payment, diverting money to pay off debt can lower your debt to income and increase your credit score. An increased credit score can qualify you for a lower interest rate and may save you money on related home expenses like property insurance.
To Sum It All Up
Obviously, managing your debt is a very big thing when it comes to qualifying for a home loan. It is something that you must pay attention to, but debt is nothing that a motivated person can not overcome. Simply put one or several of the methods above into use and you may soon find yourself living the lifestyle of a happy homeowner.
