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Do you want to buy a home but debt is standing in the way? A high debt-to-income ratio makes it difficult for would-be homebuyers to qualify for a mortgage. Monthly debt payments also reduce your budget available for housing.
Although debt makes it harder to purchase a home, it doesn’t rule it out. Buying a house while you’re in debt starts with improving your debt to income ratio.
What is DTI and why does it matter?
Debt-to-income ratio, or DTI, tells lenders your ability to repay a loan. If you have a low income and a lot of debt, you’re more likely to struggle making monthly payments compared to a buyer with more income or less debt.
A lower DTI is better when it comes to buying a home; Business Insider notes a ratio at or under 36 percent is ideal. Some lenders accept a higher DTI if a buyer has a high income or cash reserves.
3 ways to lower your DTI ratio
1. Reduce debt
The best way to improve your DTI is to pay off debt. Not only does reducing debt increase creditworthiness, it also stops you from wasting money on high interest rates.
What if you have more debt than you can handle? Before turning to bankruptcy, which can stop you from buying a house for up to four years, look to debt relief solutions that keep credit intact. Borrowers can enroll in a debt management plan, refinance, or consolidate debts using consolidation loans or balance transfer credit cards. The options available depend on your personal financial situation as well as the laws in your state, so contact a debt relief agency if you’re unsure where to start.
2. Increase income
Do you have trouble making debt payments each month? If debt relief solutions aren’t right for you, increase your income to improve your DTI ratio and pay off debt faster. Try asking for a raise, applying for a better paying job, or picking up a second job or side hustle. If a side hustle sounds right, note Entrepreneur suggests gigs like food delivery, personal shopping or rideshare driving for maximum profitability.
Since this strategy takes time, it’s not ideal for delinquent debts. However, if you’re making minimum payments and want to pay off debt faster, more income could be the answer.
3. Make a large down payment
A big down payment doesn’t change your DTI ratio, but it does make a mortgage more affordable despite high debt. That’s because larger down payments lower your monthly house payment. While certain mortgage programs offer down payments as low as 3%, a larger down payment is a smart move if you have a high DTI ratio.
Of course, saving money is tough when you’re in debt. To maximize your down payment, take advantage of down payment assistance programs in your state.
How to avoid more debt
Staying out of debt long-term requires changing your spending habits. Otherwise, it’s only a matter of time before you’re drowning in debt once again.
Avoid taking on more debt as you prepare to buy a home. Not only does this improve DTI, it also helps your credit score by preventing hard credit inquiries. This may mean delaying large purchases, but it’s well worth it to finally own a home.
What about credit score?
DTI is only one factor in a homebuyer’s creditworthiness. As you pay down debt, take steps to improve your credit score as well. NPR explains this includes maintaining low credit utilization, paying off your balance every month, and avoiding new lines of credit.
Not sure where your credit stands? Homebuyers can learn their credit score through their bank, a credit score service, or directly from a credit reporting company.
It’s worth improving your finances before buying a home. Not only is it easier to qualify for a mortgage with less debt, but better financial standing leads to more advantageous lending for homebuyers. By getting control of your debt now, you can improve your financial security for the long-term — in a home of your own!
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