It is rather rare for a home-buyer, especially one who wants to qualify for a home loan for the first time, to have little to no debt. Whether its student loan debt or credit card debt, they usually have something which needs to be paid off. This leaves many people wondering if it is possible to get a home loan without having to pay off a lot of debt first.
The answer entirely depends, as the bank will take several aspects of your financial standing into account. The majority of their decision (i.e. the mortgage they will be able to offer you and the accompanying rate) it will all come down to something called the ‘debt-to-income’ (DTI) ratio. It is defined as the total amount of GROSS monthly income, relative to your monthly debt payment. Certain lenders are known to have their own set of restrictions when it comes to the DTI ratio, so it is best to check with each of them individually.
When you visit the bank and ask for a loan, they will consider both your existing debts and the potential monthly payment for a house as the total amount of debt you might have, and then use that to calculate your DTI ratio.
For example, say that you have a monthly gross income of $4,000 and you want to apply for a conventional loan where your DTI ratio cannot exceed 36%. 36% of $4,000 is $1,440, which means your TOTAL monthly debt cannot be any higher than $1,440. If you are one of the lucky few who has zero debt, you can pay up to this much for a monthly mortgage payment. If you have an additional $500 monthly debt, however, your monthly mortgage payment cannot exceed $1,440 – $500 = $940.
Now, suppose you wanted to buy a $250,000 home and you are able to afford the down payment of $50,000 (20% of the home purchase price). You would take out a mortgage loan for the remaining 80% ($200,000) that has an interest rate of 4%. 4% of $200,000 is $8,000 paid off per year, which means that your monthly payment on interest alone is $8,000 / 12 = $667. That’s not even factoring in property taxes, insurance or the principle balance of the mortgage itself! Assuming you are debt-free with a monthly gross income of $4,000, you are barely able to make monthly mortgage payments – if at all – on the house!
Clearly, there is a significant advantage to paying down your current debt before qualifying for a loan, if you are able to do so. It allows you access to larger mortgage amounts without having to increase your gross monthly income or put more money into a down payment.
You might be in a situation where you have too high of a DTI ratio for a conventional loan, but still be able to qualify for a loan where the requirements for the DTI ratio are more lenient. As previously mentioned, FHA loans and VA loans generally allow for higher DTI ratios. You could certainly apply for those, and you get the added benefit of a down payment as little as 3.5% (0% if you can specifically qualify for a VA loan).
At the same time, it is possible that your DTI ratio exceeds the allowable limit of all loans available. In this scenario, you do not have any other choice than to significantly reduce the amount of debt you have in order to lower your DTI ratio. You don’t need to pay off every single cent, but you do need to get to the point where you can comfortably qualify for a loan.
Here are several other options for you to choose from, should you find yourself in this kind of situation:
- Lower your monthly minimum payments for your debts as much as possible
- Reduce your monthly living expenses
- Pay off credit cards in order of lowest balance to highest, and/or spread out credit card debt across multiple cards (if applicable)
- Allocate more of your income towards paying off your debts
- Increase your income
- Search for a different home that will allow you to get away with a lower monthly mortgage payment
To answer the question, it is only possible to qualify for a home loan without having to pay off a lot of debt under very specific conditions. Even if you can qualify with a lot of debt, you will have to take special steps to avoid acquiring any new debt (i.e. costly purchases, getting any additional credit cards, etc.) while paying off your old debts. This will help ensure that you can continue to reliably pay off your debts after the home is officially yours. Furthermore, any significant purchases are best made after the home has been bought and acquired. For the majority of people, they will need to fix their debt first before they can get pre-approved for a loan.
Don’t forget that there are other house payments you will need to make – maintenance, utilities, home repair & renovation, property taxes, and much more. There are multiple juggling acts that need to be taken care of when you own a home, and having excessive amounts of debts will only make home ownership more difficult and stressful for you.
The best medicine is always the one that is preventative, and in this case your best option is to start reducing your debts as early as possible. The sooner you can come up with a game plan to reduce your current total debt and execute it, the sooner you will be able to qualify for a mortgage loan on the home of your dreams.
Let Us Lend and our qualified mortgage lending partners, can help you find a loan that is the right fit, having decades of experience in helping veterans, first-time homebuyers and the credit challenged. If you feel you’re ready and want to move forward with purchasing a home, click the button below and let’s see how we can help you complete this life goal!
