Mortgage lenders use a special formula called a payment-to-income ratio sometimes also called a debt-to-income ratio. It’s a calculation of your total monthly consumer payments plus a proposed mortgage payment divided into your gross monthly income. Generally, mortgage lenders will use a maximum debt-to-income ratio of 43% which represents a qualified mortgage. Fannie Mae and Freddie Mac on conventional loans will generally allow up to 50% as long as it passes automated underwriting. VA actually will go to a 63% debt ratio and FHA can go as high as 56.99. The debt-to-income ratio represents how much debt you have in relation to your monthly income. The higher the number, the greater the risk for the bank, and the more risk factors come into play. So the lender takes into consideration the mortgage payment plus your other consumer debt, and this is including all student loans, personal loans, car, loans, and monthly credit card debt.
Here’s where the rubber meets the road, let’s say in order to qualify for a $700,000 home you need to free up $300 a month of payment. You can either spend more money down or you can do a little know lending strategy called paying off debt to qualify. This means by closing the debt you presently carry will be paid off in full subsequently, lowering your debt-to-income ratio and improving your purchasing power freeing up to $300 a month in this example. Let’s say the $300 a month could be accomplished by paying off 0% interest credit card debt. Let’s say it costs $10,000 of cash for $300 a month of payment relief, allowing you to qualify for the home you want. You give pushback to the mortgage company because you’re not paying the interest on that credit card debt. Well, that might be true. Here is the reality, free money or not it’s still adversely affecting your debt-to-income ratio so you have to ask yourself if being able to get the higher-priced home is worth it for your family in the long term than the value of the temporary relief of free money as a relates to keeping a credit card? If the answer is, it’s more important to have the free money on a temporary basis then it might mean having to reevaluate a different price point or possibly look into a different neighborhood. Paying off debt to qualify is a fantastic strategy that is prudent and makes sense and only helps your ability to support a mortgage payment and drive affordability.
The bigger picture here is buying a house, right? So the notion of saying I don’t want to pay off credit card debt even though it’s the best possible obligation to improve my parent power because the 0% interest doesn’t really hold a whole lot of water because, at the end of the day, you still owe the money on the credit card anyway. More than likely at some point, the interest rate is going to radically increase. It would be a better use of your money to pay off the debt to qualify driving affordability while maintaining a monthly budget while at the same time being able to purchase the home that you can want comfortably and safely support versus keeping in credit card debt. Consumer debt only works against you when buying a home.
The only way that credit card debt ever benefits you as relates to buying a home is by keeping a healthy credit score and you can accomplish this by paying off the credit card in full each month as you go.
Don’t carry credit card debt if you can otherwise avoid it, for a few reasons
- interest is extremely expensive in most cases, particularly now the Federal Reserve is increasing interest rates
- adversely affects your debt-to-income ratio limiting your purchasing power
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