Do you have too many credit cards, or student loans? Have no savings? Think homeownership will never be possible for you? Well, don’t worry, you can buy a house with debt. Here’s how:
Check your debt-to-income ratio: The debt-to-income ratio compares your debt to your income. To calculate your personal debt-to-income ratio, you will divide your monthly debt owed by your monthly income. For instance, if your monthly debt is $2,000 and your monthly income is $6,000, then your actual debt-to-income ratio is 33%. Give special attention to this ratio because it affects your loan eligibility to a great extent.
Lenders are likely to approve your loan application when your DTI ratio is less 40%. If your debt-to-income ratio is more than 40%, then it’s a problem. You need to think about ways you can pay off debts and reduce your DTI ratio before buying a home. A high DTI ratio signifies to lenders that you’re less likely to pay off the new loan. Many lenders won’t take the risk.
Consolidate your unsecured debts: A debt consolidation program can help to reduce your debt-to-income ratio. Such programs can consolidate your multiple bills into a single low monthly payment plan and improve your borrowing power. You won’t have to make multiple payments in a month.
Let’s understand this clearly. Say, for example, you owe $2,400 per year in debt. Your monthly payment on 5 credit cards is $200, and your debt consolidation program allows you to lower your monthly payment to only $100. This would drop your annual debt to only $1,200, and save you an additional $1,200 every year.
Now calculate your new DTI ratio. Isn’t it lower? The lender might agree to give you a mortgage now.
Save money for a down payment: Some people avoid buying a home thinking that they have to make a 20% down payment before they can purchase a house. But this isn’t mandatory. For example, the minimum down payment you need to make on an FHA loan is 3.5%. For a traditional mortgage, you can just make a 5% down payment if you want – after all, the 20% down payment is dead.
Usually, the more money you put down, the lower the interest rate you’ll get on your loan, meaning you’ll spend less money on your house in the long run. However, if you don’t have the extra money, you can always opt for the minimum down payment option. So don’t panic.
But if you want to spend less on your home in the long run, then save money for a larger down payment. Don’t give up the hope of buying your dream home just because you have debt obligations. Try to pay off your unsecured debts through debt relief programs and save the required money for the down payment.
A Few words of wisdom
Don’t borrow from your retirement savings accounts
Yes, you can borrow money from your retirement savings accounts. You can take out a loan against your retirement savings and pay off your debts to reduce your DTI ratio. But most personal finance experts and bloggers don’t recommend this. If you have no option but to borrow money from a retirement savings account, then try to pay off the loan as soon as possible. Since you already have debt, it doesn’t make sense to spend the rest of your life paying off your 401(k) loan. Create a payment schedule to repay the loan within a short period.
Stay below your range to avoid problems in the future
Even if the lender is ready to give you a loan amount that is more than what you need, don’t accept it immediately. Lenders may agree to give you a large amount when your FICO score is good. But that doesn’t mean you should grab it. Be frugal and buy a home within – or under – your budget. Be practical and choose a loan that you can easily tackle in the long run. It shouldn’t create added financial pressure on you.
If you buy a house you can’t afford, you’re increasing the chances of foreclosure in the future. When you buy a house within your price range, you can have extra money for home improvements or an emergency fund.
It’s better to buy a house after making proper plans. You can buy home with debt, but that doesn’t mean you should jump at the chance instantly. Right after you buy a home, there are many expenses that you must cover, such as property tax, homeowner’s insurance, utilities, and more. If your down payment, mortgage, and housing expenses leave hardly anything in your bank account at the end of every month, then you’re going to be in trouble.
A house can be a big asset, but not when you’re forced to spend every cent you earn on it every month. Buy a house when your debts are under control. If your mortgage eats up more than 33% of your income, it’s probably best to rent. Watch out for the ways to increase your income and pay off debts before taking out a new home loan.
Author Bio: Stacy B Miller is content writer and editor at Oak View Law Group who has written plenty of articles exploring complex financial topics. You can connect with her on Twitter to follow her recent activities in web writing.