Tip #6 in our serious on how to save money when buying a house is to Pay Down Your Debts Paying down your debts does two things: it increases your credit score, resulting in a lower interest rate. Your score goes up because with less debt you are less of a risk of defaulting. And second, it allows you to get a larger mortgage because your debt to income ratio goes down. A simple way to determine if you will qualify for a conforming loan is to see if you meet the 26/38 ratios. All of your monthly debt payments cannot exceed 26% of your monthly income.
So if you earn $1,000 a month, your debt payments (credit cards, student loans, etc.) cannot be more than $260 a month. This ratio does not include rent or mortgage payment. The second ratio does include the mortgage payment. Your monthly debts added to your mortgage payment cannot exceed 38% of your monthly income.
So if you earn $1,000 a month, your total payments - debt and mortgage - cannot exceed $380 a month. If you pay down your debts, your monthly debt payment will go down, allowing you to make your mortgage payment higher until you get to 38%. The larger your loan, the higher the payment. So the less you pay others every month, the higher mortgage payment you can have and still qualify. These ratios are for conforming loans. These are the loans that offer the lowest interest rates.
Some loan programs let you go above these ratios, so it is best to check with a good mortgage broker. These other loans are called non-conforming or even sub-prime loans. These loans have a higher rate then conforming loans and are not offered by most banks. If your ratios are at the limit you might have to come up with a larger down payment in order to keep the interest rate low.
So paying down your debts helps you by lowering your rate, and by allowing you to use less money down. Also, please do not make any huge purchases before you get your mortgage. I sometimes have clients who while waiting for their house to be built go out and buy new cars and new furniture for the house, all on credit. This can screw up your ratios and add debt that can hurt you. Your credit score will go down because a. you have more debt, and b.
because you have more inquiries on your credit report. So please, wait to buy the car, house, blinds, whatever until after you close on the house.
Abby Kamadia, is a mortgage consultant, and real estate broker in Houston Texas. For the 69 other free articles on saving money when you buy a house visit Abby's Houston Texas Real Estate website.
