Mortgage shoppers with big household debt may be wondering if they can actually get a home loan, and if so, what are the best strategies to use - and how should they use them?
It's certainly a good time to look, with 30-year fixed mortgage rates hovering out around 3.86% in late August, according to HSH.com. But can "deep debt" home buyers even sniff at such a decent rate?
Mortgage consumers in the same boat have done so, and done so very successfully.
"I have first-hand experience with getting a home while having big debt," says J.R. Duren, a personal finance expert at HighYa.com, a consumer money management site. "My wife and I bought our house on May 31, even though we have a combined student loan debt of more than $130,000, credit card debt at $12,000 and a car loan at $6,000."
In his experience, Duren says a big issue in landing a mortgage when you owe big money to creditors is your debt-to-income ratio. "If your monthly payments, along with your other debt obligations, are less than 40%, you're good to go in pretty much any situation," he says. "Most loans, however, are in the 43-44% range when it comes to debt-to-income, so borrowers need to keep that in mind."
Another factor in Duren's favor was that his combined loan burden loans were being paid back with an income-based repayment plan. "Thus, my lender was able to get me a Freddie Mac loan that calculated my payments based on what's listed on my credit report which, at the time, was $153," he adds.
Duren is hardly alone. Others with big debt have traveled the same and emerged unscathed financially, and with a new home.
"Last year, I bought the house of my dreams despite having a medical school debt of over $120,000," says Dr. Goldie Winge, a board-certified anesthesiologist with a self-proclaimed passion for real estate, who resides in Rancho Cucamonga, Calif. "The key to securing a home loan with big debt is to have excellent credit and good financial reserves."
Winge says her strategy was to pay off all of her credit cards, which freed up available credit. "I also kept credit inquiries to a minimum and consistently paid all of my bills on time," she explains. "These all helped to boost my credit score."
Winge also put money into her retirement accounts and consistently saved money in a bank savings accounts after taxes. "The physician loan I used required six months of mortgage payment reserves," she says. "They counted 50% of the money in my retirement accounts towards my reserves, which was very helpful." (A physician loan allows medical professionals, who have accumulated high student loan debt as well as personal debt while pursuing their degree, to get good financing on a mortgage, says Tal Frank, President of Physician Loans, in Columbus, Ohio.)
Lastly, Winge, like Duren, made sure her debt to income ratio was lowered by changing one of her student loan repayment terms to 20 years instead of 10. "This helped to greatly decrease my monthly debt to income ratio, which freed up more money for my mortgage," she notes. "I'm still able to pay more than the minimum amount, which will allow me to pay my loan off well before 20 years."
It's really not rocket science, financial experts say. If you can convince a lender you're a good credit risk, even if you have big debt, you can get a good home loan.
"A buyer with large debt balances can still purchase a home if they demonstrate the capability to repay," says Christopher Aldridge, a managing director at DRI Fund, in Southfield, Mich.
Aldridge, who also cites debt-to-income ratios as a big factor in getting a loan approval, says there are three effective strategies that can improve the DTI ratio of a home mortgage shopper:
1) Instead of maxing out the down payment, look for a low-down payment product. "Use any accumulated cash plus gifts to pay off debts that can be eliminated," Aldridge advises. "The impact of eliminating bills with $500.00 in monthly payments increases your mortgage capacity by over $100,000 for a 4.25% 30-year mortgage."
2) Similarly, if you have the potential of restructuring your debt to lower rate or longer-term consolidation loan, you could lower total fixed debt payments. "The monthly payment reductions would produce the same benefits," he notes.
3) Ask your lender for a product with lender paid private mortgage insurance (PMI). "The lender covers this expense by increasing the loan interest rate," Aldridge states. "The savings from eliminating PMI payments can save as much as $100 per month."
High debt consumers have plenty of reasons to believe they can still realize the American Dream of home ownership. "The key is understanding how your debt obligations impact a lenders decision before applying for a loan, and taking action to manage its impact on your approval," Aldridge says.
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