When buying a home, debt isn’t always a bad thing. While cash is king and the thought of a debt free life sounds great, most people can’t pay for a house with cash and will need to rely on obtaining a mortgage in order to be a homeowner. You need some level of debt to establish credit in the first place. Long term debt is a form of healthy debt that can boost your credit score and increase your chances of getting a mortgage.
The Longer Your Credit History, The Better Your Score.
Mortgage lenders use credit scores as one of the factors when deciding whether or not to lend to you. They want to see on your credit report that you have a long history of making regular payments. The longer your credit history, the better your chances at a lower mortgage rate are.
Most millennials are struggling with student loan debt. This is not necessarily a deal breaker with mortgage lenders. Paying off this form of long term debt regularly can be one of the first things that establishes your good credit.
Debt to Income Ratio
This is another huge factor in whether or not a mortgage lender will qualify you for a home loan. Your debt to income ratio is all of your monthly debt payments divided by your gross monthly income. To qualify for a mortgage, it’s advisable to have a debt to income ratio below 43%. You can calculate your debt to income ratio here.
Mortgage lenders also look at your secured and unsecured debt. A secured debt, like a car payment, is more favorable because it is backed up by an asset, often called collateral. A mortgage itself is a form of secured debt and looks favorable on your credit report.
Unsecured debt is debt that does not have collateral to back it up, such as credit card or student loan debt. You want to keep your unsecured debt levels low.
Revolving debt is a debt you keep paying off and adding to, like a credit card. You want to keep your credit usage under 30% of your max credit limit to maintain decent credit. If you are constantly maxing out your credit cards, it shows lenders that you are often strapped for cash and may have trouble keeping up with a mortgage payment.
Keeping your credit line open and active for a long time can greatly improve your credit if you keep the usage at around 10% of your limit.
Debt You Want To Stay Away From
Always steer clear of high interest payday loans. These loans offer quick cash for people with poor credit, the high fees, insanely high interest (up to 300% in some cases), and other penalties. However, they are almost impossible to dig out of if you miss a payment, and negatively impact your credit.
Having some debt is good for your credit and will look more favorable to mortgage lenders than no debt at all. The key is to keep the good debt, like secured and long term debt, while reducing your revolving and unsecured debt to a workable debt-to-income ratio. Good debts improve your credit score leading to lower interest rates and better deals on a mortgage.
Homeownership does not need to be a distant dream if you have student loan or other good debts. Using it to develop healthy credit can actually help your chances at buying your own home.