5 ways to reduce your debt before buying a home
Image: Mashable Composite/Christopher Mineses
For Generation Y buyers, that figure is as high as 97%, according to the report.
As many home buyers have learned, the process of qualifying for a mortgage can be both tedious and nerve-wracking. Lenders seek to know everything about a potential borrower's past and current finances to ensure that he or she has the cash flow to make monthly mortgage payments.
Here are five ways borrowers can reduce their debt, increase their cash flow and achieve a low debt-to-income ratio before buying a home.
1. Prune away credit report inaccuracies
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"Nothing is overly minute when it comes to making sure your credit score is current and accurate," says Michael Bovee, president of Consumer Recovery Network, a self-help website to resolve credit issues.
Appearances matter on your credit report, and multiple addresses can give off the impression that you're financially unstable. Bovee advises consumers to delete old addresses from their report. He also urges them to contact credit agencies about paid bills that are still showing on credit reports.
"Those shouldn't be there anymore, and they'll follow you around for years if you don't pay attention," Bovee says. "They can affect your score, how you're viewed and your interest rate."
Even if a potential borrower doesn't find any errors or discrepancies on his or her credit report, it's good for him or her to get in the habit of regularly checking its contents.
"It greases the wheels," Bovee says. "It'll get you accustomed to the process of making sure that everything on your credit score accurately reflects your current information."
2. Remove co-signed obligations
When preparing their finances before a home purchase, many consumers overlook obligations that they've co-signed in the past, such as a relative's credit card or a student loan. Though they may not make payments on those obligations, consumers are still responsible for them in the eyes of lenders, who view co-signed obligations as debt and a borrowing risk."It's all about what's on paper — just the facts," says Scott Sheldon, a senior loan officer at Sonoma County Mortgages.
Sometimes removing a name from a co-signed obligation can be as easy as placing a phone call, Sheldon says. In the end, removing outside responsibilities from a credit report can free up buyers to borrow more, he adds.
3. Attack large and high-interest balances and improve cash flow
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To assuage future lenders, consumers should devise a monthly budget that allows them to pay down their credit cards to 30% or less of their credit limits. Not only will this tactic trim monthly payments on the card (which are likely subject to interest), it'll also refurbish the card holder's credit score and lower his or her debt-to-income ratio.
"It’s like a three-in-one punch," says Sheldon. "The borrower will have a better FICO score, a better DTI ratio and better ability to qualify for a home because less their income is mortgaged."
To get started on paying down credit cards, consumers should set aside money each month to whittle away at their cards that have higher interest rates and larger balances, Bovee advises
"You can take someone from zero to hero using their monthly cash flow in six to 12 months, if they have that time," Bovee says.
By attacking those balances, consumers will vastly improve their cash flow, which is central to a lender's decision.
"Us lenders don't care so much about the amount of debt someone has, per se," Sheldon says. "It's the minimum payments associated with that debt that draws the line in the sand between having good probability of qualifying and having a worse probability of qualifying."
"The person with more debt and lower monthly payments is actually better off from a loan qualifying standpoint than the person with less debt and a higher monthly payment," he adds.
4. Negotiate unresolved debt on your own
Though you may have outstanding debts that have gone to collection, you can still qualify for a mortgage in the future, especially if you take prudent steps to bandage debts and erase balances from your credit report.To start the debt triage process, consumers should reach out to their creditors or collectors and offer to pay half of their sum — or, in some cases, less, Bovee advises.
The end goal, Bovee says, should be to remove all unpaid bills from a credit report and receive documentation that the cases have been closed. With a tidier credit report, creditors will be less skittish about lending to you.
"Because the damage is already done to your credit, you need to get the balances updated to show there's nothing owed," Bovee says.
"Then, that person with three collections on their report today, as long as they're able to put a plan together and enact it over the course of the next six months, could be in the home-buying market by winter."
5. Consolidate debt
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"That'll have a ripple benefit effect," Sheldon says. "Those other cards will now show zero balance, which improves utilization of credit, and you'll have a lower monthly payment, which will bolster your ability to qualify for a mortgage."
Like Sheldon, Bovee stresses the importance of reducing your debt through traditional means, such as consolidation. He advises against alternative ways to slash debt like debt settlement or credit counseling, both of which can hurt your credit in the long run.
"Use peer-to-peer lending or banks that are back in the credit consolidation market," Bovee says.
