If your goal is to buy a house, but you are worried about paying off your debts first, don’t worry. Not all debts are bad, and having some debt is healthy. It all depends on how your debt relates to your income and whether you can manage it. If debt feels like a burden, know that even if you have to start small, you can learn how to get out of debt and become a reality.
This Redfin article outlines strategies that will help you get out of debt to buy a home. Whether you live in Kansas City, Missouri, or look at your home in Charleston, South Carolina, there are things you need to know about the debts you need to buy when buying a home.
The best way to understand DTI is to talk to your lender and get approved in advance for your mortgage. The lender can tell you what you qualify for and whether you should try to pay back your debts to get a better loan.
For traditional loans, lenders usually prefer DTIs of 42% or less, including mortgage payments. DTA requirements vary for other types of loans, such as FHA and VA. DTI alone does not determine whether you are eligible for a loan, so the exact number is less important than knowing what debt you have or how it affects your loan options.
What is included in the debt-to-income ratio?
Most types of debt are included in DTIs, but some are not. Knowing which is which can be helpful. This allows you to focus your efforts on getting out of debt in the most effective way.
Debts included in DTI
Since lenders have cars as collateral, car loans are “liabilities.” If you don’t pay the loan, the lender can get the car back. Having a car loan can be a good point for you, as it is more difficult to get an approval for a car loan than a credit card. Credit card liabilities are considered unsecured liabilities as there is no collateral for the bank to regain. Too much debt from your revolving credit card (an amount that is not repaid each month) can affect your loan approval. Student loans are another form of unsecured debt. As long as you demonstrate your track record of paying on time, there’s nothing inherently bad about student loans. Unfortunately, student loans can be important and can take years to pay off. This can affect their ability to qualify for a mortgage. Learn more about buying a home with student loan. Payday loans are usually not displayed on your credit report. However, if you don’t pay the loan and the company reports it, it can appear in your credit report. Interest rates are also very high, and if you miss a payment, it will be added immediately, affecting your DTI and potential mortgage approval. Any alimony or child support paid as part of a divorce order will count as part of a DTI along with a personal loan.
Debt is not included in DTI
Medical or Debt Mobile Phone Invoice Utility Invoice Rental
Now that you can better handle what type of debt you have, you can take steps to reduce it. But before you start cutting your credit card and call all debt relief agencies that run ads on late night television, see how such services work.
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Things you need to know about debt relief services
Some debt relief agencies are non-profit organizations that provide guidance at low cost or free of charge. Others are for-profit businesses that charge you, and some are scams that can’t provide what you’re paying for. It’s important to know the difference.
Credit Counseling Organizations can help you manage your money and debt. In addition to free educational workshops, trained counselors can work individually to create personalized plans, often with debt settlement. When you combine your debts, you move your balance to your card and make one payment instead of a low interest rate, rather than a large number of interest rates. To find a credit counselor, visit the National Credit Counseling Foundation. Debt settlement programs are usually provided by commercial companies. Their approach is to negotiate with creditors and allow them to pay a “settlement” amount to settle the debt. This is usually a lump sum payment. To make that payment, the company asks you to secure a certain amount of money in savings each month. You are usually instructed not to make payments outside of this arrangement. Please note: Creditors are not obligated to negotiate. Please read all terms and pricing carefully before agreeing to work with the settlement company.
If you choose to get external help, do your research. Find out what services your organization offers, how much it costs, and how long it will take to get the promised results. Get everything in writing and read the contract carefully before signing it. Learn more about how to choose a debt relief service.
How to get out of debt yourself: Take a proven approach
If you’re looking to buy a home, the first step is almost always to talk to the lender and get approved in advance. This gives you an inside look at how your debt affects your home buying outlook.
If you already know that your debt is not where you want it, think about these DIY options one step at a time to get it back on track.
1. Understand the starting point
Before deciding on your future path, you need to be clear about where you stand. Collect all your profit and loss statements and invoices and list all your liabilities from the lowest balance to the largest balance.
2. If possible, stop using your credit card
Stop and pause impulsive purchases before purchasing unwanted items. After all, you want to get out of debt quickly and buy a house. A little sacrifice can go a long way to help you become a proud homeowner!
3. Building a small emergency fund
This will protect you from the temptation to withdraw your credit card in the event of an emergency. Consider entering a $1,000 or two-month expenses in your savings account. This reduces stress and sets it up to launch a debt attack.
4. Tackling debt using the snowball method
Take a list of debts that are organized from minimum to maximum and start paying them off. The short-term goal is to start cutting your list. How does this work:
Identify the minimum balance. Make bigger payments with this balance while you continue to make the minimum payment for your larger balance. Continue this every month until the minimum balance is repaid. Start repayment of the next minimum balance. Keep this up until your biggest debt is paid back or reach a more comfortable level of debt.
Remember, you don’t need to be in debt to buy a house. Perhaps you don’t have to wait until all your balances have been paid back before applying for a loan. However, many people use this method to pay off their credit cards faster, make debt more manageable, and get to a better position to qualify for a mortgage.
5. Lower the interest rate
Lower fees on credit cards or personal loans save interest money and make it easier to pay off debts quickly.
Switch to a credit card with a lower rate. Depending on your credit rating, you can qualify for a low interest credit card or a credit card with an introductory rate of 0% for 12 months or more. You can save over $1,5000 on your card that charges 29%, and by transferring your balance to one with 0% interest for 18 months, you can save more than $1,500 a month. That’s the extra money you can use to pay off your card.
Get a loan at a low interest rate. Another option is to remove high-profit personal loans. Personal loans often have lower interest rates than credit cards. You may need to put cash in your account as collateral, but it’s worth it if you can lower the fees. You can also refinance your car loan or consolidate your student loan if you can search for a bank or credit union or search for student loan consolidation companies to find a provider with a lower interest rate.
6. Pay more than the minimum amount
You can always pay the minimum monthly payment. Take a look at that $5,000 credit card bill and see how payments above the lowest can help.
Let’s say your interest rate is 15%. Paying only a minimum of $114 will take over 5 years. If you can increase your monthly payment to $300, you’ll pay your card back in just 19 months and pay just $600 of interest. Big difference!
A big change equal to a small step
In addition to the steps above, you can ask yourself if you can make lifestyle changes to save money and spend that money to pay off your debt. Consider cutting cable services, cooking at home, brewing your own coffee, or switching to an inexpensive hobby. Remember that lower costs now is a way to get out of debt. You don’t have to live this way forever, but you may find yourself grateful for your new habits.
Getting out of debt takes much longer than getting it in the first place. But when you are motivated by a dream of homeownership, learning how to get out of debt with hard work and baby steps is the way. Each dollar you can save to pay off your debts is one step closer to your new home.
