You’re looking to buy a home, and it’s time to start looking at your finances to figure out what you have going on. You have some outstanding credit card debt, a car payment, and student loans.
Do you need to pay off those debts in order to qualify for a mortgage? Well, not necessarily, but in today’s mortgage world, paying off debts to qualify for a mortgage is absolutely possible.
What should first be looked at is the guideline lenders must abide by – the debt-to-income ratio (DTI). The DTI is a calculation for what percentage of your monthly pre-tax income goes toward the monthly expenses you carry and cover.
The ratio you’re looking to not surpass for conventional loans, aka loans that are sold to Fannie Mae and Freddie Mac, is 45%. This means that all of your monthly payments need to fit within 45% of your pre-tax income.
Now that we have that out of the way, you should figure out if your DTI is equal to or less than 45%. If it is then great. If not, then you’ll have to do some work to knock it down, and this is where paying off debt comes into play.
Credit cards are typically the first place to look when you’re looking to pay off current debts. Credit cards typically carry the highest interest rates, and paying those off will be beneficial in both the short term and long term. You don’t have to close the account, you just need to document that the balance is at zero.
If we can show that the funds used to pay off those debts to zero were from legit sources (not your winnings from last night’s poker game), then the payments on that debt can be excluded from the debt-to-income ratio calculation.
But the key is to keep those balances at zero for the duration of your home purchase or refinance. If you pay off your Target card but then go on a home decorating spree after you get an accepted offer, those new purchases and the new balance on the card will show up when a lender gets refreshed credit a few days before closing.
So keep it at zero if the numbers are that tight.
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