Buying a house is an exciting milestone in life. However, taking on a mortgage is a huge financial commitment that involves weighing your income, savings, credit score and existing debts. If you have a significant amount of debt, you may be wondering if homeownership is possible for you right now. The answer is not straightforward. While debt can impact your ability to qualify for a mortgage, it doesn’t necessarily mean you can’t buy a house. With some strategic planning, you may still be able to become a homeowner, even with high debt.
How Lenders Evaluate Debt When Buying A House
When you apply for a mortgage, lenders want to see that you can comfortably afford the monthly payments They will look closely at two key factors – your debt-to-income ratio and your credit score
Debt-to-Income Ratio
Your debt-to-income (DTI) ratio compares your total monthly debt payments to your gross monthly income. It’s calculated by dividing your total monthly debt by your gross monthly income. For example, if you have $2,500 in monthly debt payments and earn $6,000 per month, your DTI is 41.6% ($2,500/$6,000).
Lenders generally look for a DTI of 43% or less when approving mortgages A higher ratio means you have less income available to cover the mortgage payment While it’s possible to qualify with a DTI up to 50% for some loans, you’ll get better rates and terms with a lower ratio.
The lower your DTI ratio, the more confident lenders will feel about your ability to manage the mortgage payment along with your other financial obligations. To improve your ratio, focus on paying down debts, increasing your income, or putting more money down to lower the mortgage amount.
Credit Score
Your credit score gives lenders an indication of how reliably you’ve paid debts in the past Most lenders look for a minimum score of 620 to qualify for a mortgage, but scores of 700 or higher will get you better rates
If you have a lot of debt, it can negatively impact your credit utilization ratio and in turn, your score. Try to keep balances low on credit cards and loans. Pay off collection accounts if possible. Disputed medical debts won’t hurt your score. Improving your credit score can help offset high debts when applying for a mortgage.
How Much Debt Is Too Much For Buying A House?
There is no universal debt threshold that determines if you can or can’t buy a house. It depends on factors like your income, assets, credit profile and the specific mortgage programs available. Here are some guidelines on how much debt lenders can accommodate:
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Overall Debt Load: Most experts recommend your total debts (excluding mortgage) be less than 43% of your income. Some lenders may approve higher amounts if you have strong assets, credit and income.
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Student Loans: Lenders can include 1% of your total student loan balance in your DTI calculation, even if they are deferred. Payments will be used if they are 10 months from ending or qualify for forgiveness.
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Credit Card Debt: Minimum monthly payments are included in your DTI. Try to keep balances below 30% of your credit limits.
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Medical Debt: Paid or unpaid medical collections under $500 won’t impact your mortgage application.
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Auto Loans: Your monthly payments are counted toward your DTI. Consider paying off auto loans if your ratio is close to 43%.
While it’s ideal to pay down debts before buying, your specific situation will determine if you can qualify for a mortgage with your current debts. Speak with a lender to evaluate your options.
Strategies For Buying A House With High Debt
Just because you have debt doesn’t mean homeownership is out of reach. Here are some tips for getting mortgage-ready:
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Make a larger down payment: This lowers the amount you need to borrow, which can offset a high DTI ratio. Lenders may offer better rates and terms when you have more equity upfront.
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Ask lenders about flexible programs: FHA loans can accommodate higher debt with a DTI up to 50%. VA and USDA loans have flexible requirements for eligible borrowers.
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Pay down revolving debt: Credit cards have a bigger impact on credit scores than installment loans. Knock out card balances first if possible.
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Consolidate debts for lower payments: Combining high-interest debts into one lower monthly payment can improve your DTI ratio. Be cautious of balance transfers impacting your credit score.
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Consider a co-signer: Adding another borrower may help you qualify by accounting for their income. But they will be equally liable for the mortgage.
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Improve your credit: Pay all bills on time, dispute errors on your credit reports and keep balances low. A higher score can help offset debts.
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Increase income: A second job or side hustle can give your DTI ratio a boost. Wait to start a few months before applying as lenders want stable income.
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Lower other housing costs: Opt for a lower-priced home, put less money down on furniture or look in more affordable neighborhoods to free up cash for your DTI.
Final Thoughts On Buying A Home With Debt
Managing your debt-to-income ratio is key for getting approved for a mortgage, especially if your outstanding debts are high. While lenders prefer to see lower debt, it doesn’t necessarily preclude you from buying if you have a compensating factor like a high income, substantial assets or great credit. Consider all options for becoming mortgage-ready, from improving your credit score to finding flexible loan programs. With proper planning, you can still achieve the dream of homeownership, even with debt.
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How much money is required for a down payment?
Many borrowers who are struggling with debt think that mortgage lenders always require at least 20% of the purchase price as a down payment. While lenders are more than happy to accept larger down payments, many loan programs allow homebuyers to pay smaller amounts. FHA loans, which have the backing of the Federal Housing Administration, often require 3.5% down payments. Loans offered through the U.S. Department of Veterans Affairs (VA) or the Department of Agriculture (USDA) may be available to eligible borrowers with no down payment.
Even conventional loans may only require 5% of the purchase price, although this often comes at a cost:
- Smaller down payments result in larger monthly payments.
- The less you pay toward the purchase price at closing, the more money you may have to borrow, which means paying more interest over time.
- A lender may require you to purchase private mortgage insurance (PMI) to buy a new home with a down payment of less than 20%. In this case, PMI may be required to be paid alongside other closing costs, such as property taxes and homeowners insurance.
How To Know How Much House You Can Afford
FAQ
How much debt is too much to buy a house?
… no more than 28% of your gross monthly income should go to your housing payment (like rent or mortgage payment) and no more than 36% of your gross income …
Can you get approved for a mortgage if you have a lot of debt?
It varies by lender, but generally, the less credit card debt you have, the better your approval odds. If your monthly debt payments, including your credit card payments, are more than 43% to 45% of your monthly income, you may have trouble getting a mortgage loan.
Can you buy a house with $100,000 in debt?
You can still get approved for a home loan, even if you have $100,000 (or more!) in student loans. But your approval hinges on more than the type of debt you have. Before approving your mortgage application, lenders also look at your debt-to-income (DTI).