When buying a house it
is best to take time in advance to get your "financial house" in order. Paying off all your credit card debt in the past was
encouraged may not
be the best move. Reducing your debt will definitely impact your credit score,
your debt-to-income ratio, but more importantly the amount of "liquid
cash" you have in the bank. Consider all three aspects carefully before
you make a final decision about your credit card balance.
Cash Reserves vs.
Credit Card Debt
Have you been building
up your savings to cover your down-payment and closing costs? Think hard before
you dip into that fund to pay off your debt.
The median price of a
home in the United States in 2014 is around $200,000, most likely you will need
a minimum of $7,000 for a down payment for an FHA loan that requires 3.5% down;
or $10,000 for a 5% down payment, the minimum required for most other conventional loans. In addition to the
down payment, you will need 3% to 5% of the loan amount for closing costs,
which comes to another $6,000 to $10,000. Looking at these two items alone you
will need between $13,000 and $20,000 in cash to buy a median priced home.
But don't forget, you
will also need money for moving expenses and for cash reserves in case of an
emergency. Not all lenders will require that you have cash reserves, but a good
rule of thumb is to plan on having at least two months of mortgage payments on
hand.
Once you have
estimated all these costs, reserved these funds and determined that you can
cover them you can safely take the additional cash you have available and pay
down or pay off your credit card debt .
What is the Debt-to-Income
Ratio
In order to qualify
for a conventional mortgage, your monthly minimum payments on all debt must be a maximum of 43% of
your household monthly gross income. If you are to be the sole loan holder then
only your income will be counted. If your partner or spouse will also be listed
on the loan then both income, debt (and credit scores) will be calculated. You
need to be aware that some lenders require lower debt-to-income ratios,
particularly for borrowers with a low credit score or those that have few cash reserves.
If your charge card debt is too high and you are "maxed out" you may
not be able to qualify for a mortgage. FHA loans do have looser guidelines, so
some lenders offering this type of loan may allow a higher debt-to-income ratio
but only under special circumstances. For your own comfort level with your
budget it’s best to have a lower debt-to-income ratio.
Clean Up Credit Score
Issues
Lenders will rely
heavily on your consumer credit scores, this is not only for the loan approval
but also to determine the interest rate you will pay for a conventional loan.
If your credit score is under 700 or 680, you may want to pay off some or all
of your debt to improve your score. If your score is 640 or lower, you may be
able to qualify for an FHA loan depending on the rest of your credit history or
profile.
Plan smart! If you
decide to reduce your debt, be careful not to combine all your debt on one credit card. Doing this
can hurt your credit score more than having a low balance on several cards. Even
more important, once you pay off an account don’t close it. Closing credit card
accounts will reduce your overall credit availability and shorten your credit
history, both of which will lower your score.
One of the best ways
to plan and make the decisions about your personal financial situation is to
consult with an experienced mortgage lender who can best advise you on what you
can do to qualify for a loan that’s affordable and fits your money management
plans.
