Pros of Paying Off Debt First
The best place to start is to address your high-interest credit card balances and any other unsecured loans such as student loans and personal loans that didn't require collateral. Paying off some of those debts will make you a more attractive mortgage borrower.
Every timely payment contributes to the borrower's good credit score. Eliminating that debt by paying it off before the mortgage application could potentially negatively impact the borrower's credit score, even if only temporarily.
Different types of mortgages have varying requirements regarding past credit issues: Conventional loans: Generally the strictest, often requiring a waiting period of 4-7 years after debt settlement.
It might just require more effort to ensure on-time payments. Or, then again, it might require paying off your loan early to lower your DTI. In most cases, though, it's better to pay off a personal loan before you apply for a mortgage.
More Liquidity
Using your extra funds to pay off your mortgage reduces the amount of money you have for other expenditures. For example, you may need to build an emergency fund, pay off other high-interest debt, or buy a new car.
It might increase your interest rate. Taking out a personal loan to cover a down payment signals to a mortgage lender that you're financially stretched and may not be able to afford homeownership. This makes you a greater risk.
Mortgage lenders want to see a debt-to-income (DTI) ratio of 43% or less. Anything above that could lead to the rejection of your application. The closer your DTI ratio is to that percentage, the less favorable your mortgage terms are likely to be. A Home Purchase Worksheet can help you determine your DTI ratio.
There is no set time limit on when you can get a mortgage after paying off your debts. As long as you meet the lender's affordability requirements, such as credit score, DTI ratio, deposit amount etc., then the amount of time that has passed since you cleared your debt becomes less important.
A: You've asked some important questions, although we think you might be a bit confused about how your real estate tax and mortgage escrow accounts work. Let's start with a basic fact: Whether you carry a mortgage on your property has no impact on what you pay in real estate taxes.
High debt-to-income (DTI)
Before approving you for a mortgage, lenders review your monthly income in relation to your monthly debt, or your debt-to-income (DTI). A good rule of thumb: your mortgage payment should not be more than 28% of your monthly gross income. Similarly, your DTI should not be more than 36%.
Delinquent credit—including taxes, judgments, charge-offs of non-mortgage accounts (see below for exceptions), tax liens, mechanic's or materialmen's liens, and liens that have the potential to affect Fannie Mae's lien position or diminish the borrower's equity—must be paid off at or prior to closing.
What's a good debt-to-income ratio? Ideally, your front-end HTI calculation should not exceed 28% when applying for a new loan, such as a mortgage. You should strive to keep your back-end DTI ratio at or below 36%.
Should you pay off all credit card debt before getting a mortgage? In some cases, especially if your current credit score makes it difficult for you to get a mortgage loan, it's a good idea to pay down credit card debt. But keep in mind that credit card debt isn't the only factor in getting mortgage approval.
According to the Federal Deposit Insurance Corp., lenders typically want the front-end ratio to be no more than 25% to 28% of your monthly gross income. The back-end ratio includes housing expenses plus long-term debt. Lenders prefer to see this number at 33% to 36% of your monthly gross income.
It means saving up an adequate down payment, identifying the right mortgage lender, checking your credit rating, minimizing your debts, setting aside cash for closing costs, and getting pre-approval for a mortgage in advance. All before you go to your first open house.
Lenders use your debt-to-income ratio to measure your ability to afford a home loan. You can calculate your DTI ratio by adding up your monthly debt payments and dividing the amount by your gross monthly income. There are both front-end and back-end DTI ratios, which take into account different types of debts.
Creditors like to see that you can responsibly manage different types of debt. Paying off your only line of installment credit reduces your credit mix and may ultimately decrease your credit scores. Similarly, if you pay off a credit card debt and close the account entirely, your scores could drop.
Consolidate into your home loan
One of the biggest potential benefits of consolidating into your home loan is having just one repayment to monitor in addition to saving on interest, which can help make managing your finances easier. You could even put what you save on interest towards making extra home loan repayments.
U.S. consumers carry $6,501 in credit card debt on average, according to Experian data, but if your balance is much higher—say, $20,000 or beyond—you may feel hopeless. Paying off a high credit card balance can be a daunting task, but it is possible.
Can you get a mortgage with student loans? It's not uncommon for a first-time home buyer to have anywhere from $30,000 to $100,000 in student loan debt and still qualify for a mortgage, Park says.
50% or more: Take Action - You may have limited funds to save or spend. With more than half your income going toward debt payments, you may not have much money left to save, spend, or handle unforeseen expenses. With this DTI ratio, lenders may limit your borrowing options.
Any existing loans or credit accounts you have are listed on your credit report, and will be reviewed when you apply for a new loan. The main factors that lenders consider in regards to personal loans are how well you've managed the loan and how it affects your debt-to-income ratio.
Lenders provide you with a lump sum of cash that you repay over a set term. While some lenders may allow you to use a personal loan for a down payment on a house, it's generally not recommended since it increases your debt-to-income (DTI) ratio.
A “piggyback” second mortgage is a home equity loan or home equity line of credit (HELOC) that is made at the same time as your main mortgage. Its purpose is to allow borrowers with low down payment savings to borrow additional money in order to qualify for a main mortgage without paying for private mortgage insurance.