Some people set a goal to become completely debt-free before buying a home – and that can be a smart move. The less money you owe elsewhere, the more you can put toward homeownership.
But here’s the truth: you don’t have to be debt-free to buy a house. It’s possible to qualify even if you have credit cards, student loans or a car payment.
What really matters is how you’re managing your debt, and how much of your income goes toward those payments.
Why Lenders Care About Your Debt
When you apply for a mortgage, lenders look at your debt-to-income ratio (DTI), which is the percentage of your gross monthly income that goes toward debt payments.
A high DTI can be a red flag that you’re stretched too thin financially. In which case, it can limit how much you’re allowed to borrow, and possibly stop a loan approval altogether.
For example, let’s say two people have the same credit score, down payment and they both earn $100,000 a year. It might seem as if they’d qualify for the same mortgage amount. However, Person A has no consumer debt, meanwhile Person B has a $700 car payment and $300 in student loans each month.
Even though they earn the same amount, Person B’s $1,000 in monthly debt payments raises their DTI and lowers how much house they can qualify for.
That’s why managing debt, and understanding how it affects your numbers, is key.
Lenders typically want your DTI to be 43% or lower, though some loan programs allow higher ratios in certain cases. Debts that factor into your DTI include:
• Credit card minimum payments
• Auto loans
• Student loans
• Personal loans
• Child support or alimony (as documented in court orders)
Basically, if it shows up on your credit report or is a legal financial obligation, it’s counted.
The Difference Between Revolving and Installment Debt
Debt isn’t created the same, so it’s important to understand how they differ:
• Revolving debt (like credit cards) can hurt you more when qualifying because the balance can keep going up and the minimum payment can change. Lenders see this as more unpredictable.
• Installment debt (like auto loans or mortgages) usually has fixed terms, which makes it easier for lenders to factor into your budget.
Since revolving debt is somewhat riskier, you might tackle this first when trying to improve your DTI ratio.
What Can You Do to Get Mortgage-Ready
Even though debt isn’t a dealbreaker when applying for a mortgage, you can take steps to better position yourself for a home loan:
1. Know Your Debt-to-Income Ratio
Don’t go into this blindly. Add up all your monthly debt payments and divide that total by your gross monthly income. This will give you a rough idea of your DTI and whether you’re within a lender’s preferred range. If your DTI is on the higher end, knowing your number gives you a starting point to take action.
2. Pay Down Credit Card Balances
High credit card balances can hurt your credit score and make you look riskier to lenders. To lower your balance:
• Stop using the card
• Ask for a lower interest rate
• Make extra payments when possible
• Cut back on non-essential spending
Even a small reduction in your monthly payment can improve your DTI and your chances of approval.
3. Accelerate Loan Payoffs (If You Can)
If you’re motivated to become debt-free before buying, you can also focus on paying down auto loans or student loans early. Every bit helps. Additionally, don’t open new accounts in the meantime. A new loan can increase your DTI and work against you when qualifying for a mortgage.
4. Talk to a Lender for Pre-approval
Before house hunting, speak with a FirstBank Mortgage expert and get pre-approved. They’ll take a closer look at your credit, income and debts, so that you can see where you stand. You may find that your current debt isn’t a deal-breaker, or they may offer tips to improve your approval odds. Either way, you’ll receive clarity and a plan.
