An average American now has a personal debt of about $38,000 excluding home mortgages. This has an impact on their ability to buy a home. It affects mortgage qualification and how much a person can save for a standard down payment.
Debts have a direct effect on home ownership due to debt-to-income (DTI) ratio. This affects how much mortgage you can be eligible for. 97% of generation Y borrows money to buy a home. According to magnifymoney.com, 63% of homeowners bought their homes with a mortgage.
A good DTI is therefore a factor that cannot be ignored when planning to take a mortgage. Here is why you should not neglect debts to save for a down payment:
When applying for mortgage, your potential financer will look for 3 things; your income, upfront payment and credit history. Sadly, with credit history, you can never tell which record your bank will pull.
To prepare, get a copy of your credit report before applying for mortgage. Make sure it’s all streamlined.
For example, fix any misinformation indicated in your credit report, sort out delinquent accounts like late account among others. If your credit score is good, maintain it to improve chances of mortgage approval.
Mortgage Loan Qualification
The cash you can afford to repay monthly determines the mortgage you are eligible for. This means if debts are consuming more money from your income, you may not qualify for the amount you need.
Now that we have established how debts affect mortgage application, does it mean you must wait till you’ve paid in full to buy your dream house? Not really. You can save as you pay off debts.
This is by no means an easy route, but it is possible. Here are some guidelines.
List all Debt
According to realisticloans, List every debt you have to ensure none is left out. This includes holiday loans, car loan, student loan and medical debt among others.
Write the minimum monthly repayment amount on each owed amount and sum it all up. Doing this will enable you to calculate how much you can save – a crucial starting point to financial freedom.
Prioritize High Interest Debt
According to some experts on CNBC.com, it is a good idea to pay off expensive debts first. You can do this by allocating more money to debts with the highest interest rate. A smaller allocation can go to the rest.
Once the most expensive debt is paid off, prioritize the next highest interest rate. This practice will save you a lot of money for the long-term. money that will increase your down payment savings.
Establish Realistic Timelines
The dream of owning a home can make you set unrealistic timelines in your plans. Failing to meet such timelines will only frustrate you.
For example, say your income is $5,000 per month and 40% of it goes to pay debts. Also, say you would like to buy a house worth $200,000. It might be challenging for you to reduce the debt-to-income ratio to the desirable rate of 12% and have a down payment of 20% ($40,000).
Open a Separate Savings Account
Readily available money is easily spent. To curb such indiscipline, put the money in a savings account. Go for one that has the highest interest rate. It will work better if you can make a specific transfer to the account each month.
Be careful if you decide to make an investment or lend out the money instead of a keeping in a savings account. These options have a higher risk and may greatly interfere with your savings goals.
Look for Ways to Increase Your Income
What if your income is not enough to save for a down payment and repayment of your other debts? Try to look for ways to improve your finances. This may mean getting a new or second job, working part time or turning a hobby into a business. Whichever it is, go ahead and implement.
However, avoid a business that could become another debt or drain your savings. Ensure the new income is distributed to paying debts and saving.
Avoid Any New Debt
Even if your debt level is below 12% of your income, avoid any credit-based transaction while preparing to apply for mortgage. Even credit card transactions affect your credit score.
Incurring new debt will make your lender doubt your financial stability. One key thing a loan officer worries about is your ability to make mortgage payment diligently. Do not taint your record by adding new debt, it is better to wait until your mortgage is approved.
Adjust Loan Repayment Plan
It is possible to negotiate for change in a loan repayment plan. For example, you can change your student loan payment plan to 10 instead of 5 years. This will decrease your monthly debt-to-income ratio, freeing up more cash for savings.
This method ensures you are not neglecting your debts in order to buy a house. It simply frees up some of your money which you can put in the savings account.
Do Not Neglect Other Savings
It would be useless to save money for a down payment only to use it for emergency. Simply because you neglected the emergency account. Likewise, it would be sad to sell your home to survive in retirement because you did not save for retirement.
Financial experts say one should have an emergency fund equivalent to three to six months’ salary. Only 39% of Americans would be able to cover a $1,000 emergency bill. The rest would end up in debt that would greatly affect their financial stability. There is therefore no justification for neglecting other saving plans.
Cut Down Your Expenses
Saving for a home and paying debts requires sacrifice. It is therefore a good time to review your life and see if there are luxuries you can do without.
Skip a holiday for one year or take a cheaper option. Sell extra cars and retain the most efficient one. Get creative in order to reduce your expenses and put the saved money in the savings account.
Saving for a down payment on a home while clearing debts requires a close examination on a personal situation. It may also require quite a change in your lifestyle to accommodate the new plans. The idea is to streamline your finances to improve chances of mortgage approval.
The 36% Rule states that your Debt-to-Income ratio should not go above this percentage. If your debts consume more than the recommended percentage of your income, you may want to hire a financial advisor – an expert who can help you manage debt and finances in order to gain financial freedom.