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If you are juggling a hefty credit card balance, a car loan, and, perhaps, even student debt, qualifying for a mortgage can be challenging. Taking out a debt consolidation loan can be a great way to combine all your debts into an easy fixed payment, but does debt consolidation affect buying a home? Let’s explore!
Highlights/ Key Takeaways
- Debt consolidation involves taking out a single loan to pay off multiple types of debt, resulting in a convenient fixed monthly payment.
- Consolidating debt can change your credit score and debt-to-income ratio, thus affecting your ability to qualify for a mortgage and purchase a home.
- Depending on your situation and consolidation method, consolidating debt can increase or decrease your chances of being approved for a mortgage, - so make sure to do your math.
- Debt consolidation can be the first step to improving your financial situation enough to purchase a home, but, most of the time, it should be done well in advance.
Understanding How Debt Consolidation Can Affect Buying a Home
Taking out a mortgage if you are already drowning in loans can be challenging. In such situations, reducing your debt as much as possible before applying for a mortgage should be the first step toward home ownership, - and this is where debt consolidation comes into play.
What Is Debt Consolidation?
Debt consolidation is the process of borrowing money with the intention of paying off multiple other loans or other forms of debt. The goal is to combine all the existing debts into a convenient fixed monthly payment, ideally with a lower overall interest rate.
For example, if you have a car loan, a couple of personal loans, some medical bills, and credit card debt, you could take out a debt consolidation loan to cover all of these payments. Instead, you will only have to submit monthly payments toward this single loan.
Common ways to consolidate your debt include credit card balance transfers, unsecured personal loans, 401(k) loans, credit counseling, and debt relief.
How Debt Affects Your Ability to Purchase a Home
When reviewing mortgage applications, one of the key factors considered by lenders is the applicant’s debt-to-income ratio. In simple words, debt-to-income ratio measures how much money you owe each month in relation to how much you are earning during the same month, expressed as a percentage.
The “debt” portion of the debt-to-income ratio often includes things like monthly rent or house payments, student loan payments, car payments, monthly child support payments, and minimum monthly payments for credit cards.
According to the Consumer Financial Protection Bureau, if you want to qualify for a mortgage, your debt-to-income ratio must not exceed 43%. The ratio that is too high might indicate to the lender that you are at greater risk of missing mortgage payments, thus impeding your chances of getting approved for a mortgage.
“Debt-to-income ratio measures how much money you owe each month in relation to how much you are earning during the same month, expressed as a percentage.”
Does Debt Consolidation Affect Buying a Home?
First time home buyer debt consolidation may or may not affect your ability to purchase a home. If, after consolidating your debts, you were able to lower your debt-to-income ratio, you will be more likely to qualify for a mortgage. On the other hand, if the process of combining your debts did not improve your debt-to-income ratio much, your chances of getting a home loan with debt consolidation would remain about the same.
Debt Consolidation Effects and Their Impact on Buying a Home
Generally, taking out a debt consolidation loan will rarely have a negative impact on your ability to purchase a home. Most of the times, it will keep your chances of qualifying for a mortgage the same or even improve them. Let us take a closer look at short- and long-term effects of debt consolidation.
Short-Term Effects of Debt Consolidation
Applying for a debt consolidation loan will require a hard credit check, temporarily lowering your credit score. The minimum credit score required for most mortgages is around 620, and bringing your score below this number can temporarily impede your ability to purchase a home.
However, if you keep up with regular loan payments, your credit score will bounce back over time, - and so will your ability to purchase a home.
Long-Term Effects of Debt Consolidation
In the long-term, debt consolidation has the potential to affect your debt-to-income ratio, the key metric considered by mortgage lenders when evaluating loan applications.
For example, if you combine your high-interest credit card debt and car loan into a consolidated loan with a more favorable interest rate, you will lower your total monthly payments. This, in turn, can reduce your debt-to-income ratio and increase your chances of qualifying for a mortgage.
Plus, keeping up with regular payments for a few years before purchasing a home can help you build a solid credit history and drastically reduce your debt load.
How Different Methods of Debt Consolidation Affect Buying a Home
Whether debt consolidation affects buying a home will also depend on the exact way you choose to consolidate your debt:
- Consolidating with a credit card. By transferring all your debt to a new credit card and keeping up with regular payments, you will be able to improve your credit score and bring down the debt-to-income ratio. Beware of high interest rates, though!
- Consolidating with a personal loan. By taking out a personal loan to consolidate multiple types of debt, you will simplify the process of paying down your debt, thus decreasing your debt-to-income ratio over time. While you might see a slight dip in your credit score, it should go back up with regular payments.
- Consolidating with credit counseling. Working with a credit counselor or a debt relief company can provide you with assistance if you aren’t able to manage the payments on your own. However, if you are enrolled in a debt management plan, you are likely not in the best financial shape and should hold off on buying a home until your situation improves.
- Consolidating through debt relief. While debt relief can help to improve your financial situation, settling debt for less than the full amount could damage your credit score, thus negatively affecting your ability to qualify for a mortgage.
Debt Consolidation Before Home Purchase: Is It the Right Choice for You?
Given that debt consolidation affects buying a home in a positive way, taking out a consolidation loan before home purchase would be the right choice for you. The catch, however, is that your debt-to-income ratio and credit score can go either way in response to debt consolidation, - so make sure to do your math and carefully choose the exact debt consolidation method.
Pros and Cons of Debt Consolidation Prior to Home Purchase
Debt consolidation is aimed at decreasing your debt, and, many times, it does just that. However, certain debt consolidation methods can actually increase your debt through higher interest rates and additional fees.
In addition, it is important to consider whether debt consolidation will hurt your credit. Certain consolidation methods can cause a minimal, temporary dip in your credit score, while others - like debt relief - can significantly tarnish your credit history. While you will be able to recover your credit score over time, consolidating your debt may delay the home purchase.
Should I Consolidate Debt Before Buying a Home?
Getting a mortgage with debt consolidation is often a good idea, given that you consider pros and cons of debt consolidation, choose the right strategy, and begin your journey well in advance. This way, you will be able to recover and further improve your credit score, reduce the total amount owed, and, therefore, increase your chances of being approved for a mortgage.
Getting a mortgage with debt is possible, but keep in mind that debt consolidation can affect buying a home in a positive or negative way. More often than not, debt consolidation can improve your financial situation in the long run, and, if done in advance, increase your chances of qualifying for a mortgage.