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How you plan and budget your finances can have a big effect on whether or not you can qualify for a home loan. For sound financial planning purposes, eliminating the expenses in your life that contain the highest interest rates first is generally a good approach. After all, why pay more interest, right? But when you apply for a mortgage, the paradigm shifts from paying off high payment obligations to prioritizing paying off debts that can improve your borrowing power. With that in, here are a few things prospective homebuyers should consider.
Banks and mortgage companies do factor in what you are obligated to pay each month as a benchmark for determining your credit capacity. This approach might not sound very logical to someone who has a large payment on a credit obligation with a great low interest rate.
A mortgage is a loan primarily against your income. The simple concept of income to offset a debt payment is what lenders look for among other things like credit, character, collateral and capacity, but income remains supreme. Gross monthly income less payments on current obligations (not what you choose to pay, but just the minimum amount owed) is how lenders will generally determine how much borrowing ability you have. (Credit scores will factor into how much interest you pay on your mortgage. You can check your credit scores for free on Credit.com to see where you stand.)
Consider a car payment at $400 per month (0% interest rate) for a remaining balance of $10,000 versus a credit card payment at $200 per month (16.99% APR) for a remaining balance of $5,000.
If you had an extra $5,000 to pay with, paying down the car would make more financial sense for buying a home than paying off the credit card, even with a 0% APR. Your payment-to-income ratio drives how much house you can really buy. Lenders compute your payment-to-income ratio in the following way:
Sum of your total current payments + proposed total housing payment ÷ monthly income = debt ratio.
Generally, with the exception of Federal Housing Administration Loans, this ratio figure cannot be more than 45% of your total income. In our car example above, paying off the car loan would free up $400 per month in borrowing ability for a mortgage. This translates to about  $40,000 in home-buying power, quite a large number indeed, especially if you’re in a competitive market.
You can follow these steps when you’re getting pre-approved:
Each and every homebuying situation is uniquely different. This information may or may not pertain to your specific situation. The whole concept is to cherry pick the obligations that pose the biggest threat to your homebuying ability and pay them off in full if possible. By paying off high debt-payment credit accounts, you also demonstrate you can actually afford the home and subsequent payment you are applying for.
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.
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December 13, 2023
Mortgages
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