Today, first-time buyers are exposed to countless “free credit score” offers online which have allowed them to be knowledgeable about their credit histories and take steps to improve their scores by the time they are ready to buy a home. However, improving credit and tackling debt are two very different things. For many buyers, especially young adults with student loan debt, high debt levels can stop them from getting financed. Mounting debt may be more harmful than lower credits scores are helpful.
Lenders depend upon three major factors in order to approve a loan application: DTI, which is the ratio of debt to income; credit as measured by FICO scores; and the loan-to-value ratio, which is discovered once a home is appraised. The credit score and loan-to-value ratio may cause the Lender to increase interest rates or limit the amount they will lend out, contingent on the appraisal.
Existing debt is important because it tells the lender about the applicant’s ability to pay back a loan. If an applicant’s DTI is too high, it greatly impacts their chances of getting financed, even if the borrower has a good credit score or job with excellent earning potential. The qualified mortgage (QM) rule regulates the cutoff for a DTI, only allowing up to 43%. This means that applicants’ monthly debt payments must be less than 43% of their monthly gross income. FHA has their own version of this rule, allowing for 41%.
Reducing your debt is the fastest and easiest solution for lowering your DTI. Below are five ways to reduce debt:
1. Become debt-aware.
Monitoring your finances and keeping track of your debt on a daily basis will help you to become more debt-aware. Utilize your bank’s online banking, money management or virtual wallet programs to help you better track your spending. By pacing yourself and staying committed, you can gain peace of mind in remaining debt-aware.
2. Pay off smaller balances.
Smaller balanced add up and can increase your monthly debt amount. By tackling these smaller amounts in one payment, you will significantly reduce your monthly payment obligations. Instead of paying the monthly minimum, pay off small balances first, then work on the larger debts in increments. If there is a line of credit that you don’t need, close the account or reduce the credit amount.
3. Consolidate monthly payments and reduce interest.
The more you owe the higher your interest rates will be on credit cards and installment plans. Bad payment history also makes those rates increase. First tackle your higher interest cards for consolidation. You can lower monthly payments by consolidating and refinancing debt. This includes car loans and student debt.
4. Stop buying with credit.
Commit to one week without buying anything with credit and see how much you save. Implementing a cash-only plan will help you to become more aware of everything you spend. By exercising restraint you can save a lot of money by making smarter spending decisions. On a daily basis, log your savings and place that amount in a savings account. This will help you pay of current debt without racking up more debt.
5. Begin with FHA.
FHA finances for applications that have lower credit scores and higher DTIs. If your DTI is over 30%, you have a better chance with FHA, than with a conventional loan. You may have a down payment, but the recent reduction in annual mortgage insurance premiums makes FHA more appealing to borrowers.
If you are in a financial crisis and are considering filing bankruptcy, contact an experienced Miami bankruptcy attorney who can advise you of all of your options. As an experienced CPA as well as a proven bankruptcy lawyer, Timothy Kingcade knows how to help clients take full advantage of the bankruptcy laws to protect their assets and get successful results. Since 1996 Kingcade & Garcia, P.A. has been helping people from all walks of life build a better tomorrow. Our attorneys’ help thousands of people every year take advantage of their rights under bankruptcy protection to restart, rebuild and recover. The day you hire our firm, we will contact your creditors to stop the harassment. You can also find useful consumer information on the Kingcade & Garcia website at www.miamibankruptcy.com.