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3 ways to manage your debt and still buy a home

Buying and Selling

Good news: It’s possible to buy a home even if you aren’t debt free.

No need to put your first (or next) home on the back burner because of debt. It’s possible to buy a house—and still feel confident. Here’s how.

1. Understand your debt-to-income (DTI) ratio.

Your DTI ratio is a number that lenders look at to decide if you qualify for a mortgage. Some lenders require your DTI (including your new potential mortgage payments) to be less than 36%. Others may be comfortable with a DTI as high as 43%.

How can you calculate your DTI ratio?

  1. Add together all your current monthly debt—credit card debt payments, car payments, student loan payments, etc.
  2. Then add your potential monthly mortgage payment to that number.
  3. Next take that total monthly debt number and divide it by gross monthly income—the amount you earn before taxes and other deductions.

So, if your current total monthly debt is $500 and your gross monthly income is $5,000, a monthly mortgage of a $1,300 would make your DTI ratio 36% ($1,800 divided by $5,000).

2. Consolidate your debt.

Debt consolidation means combining a number of loan payments—such as credit card debt or student loans—into one payment at a fixed interest rate. This can reduce your DTI ratio, as your total monthly payment will likely be less.1

Other benefits include:

  • You’ll make just one payment a month, instead of several.
  • You could pay less interest over the life of the loan or pay off your debt sooner.

3. Put down less money and pay off debt.

The good news is you don’t have to put 20% down to buy a home. In fact, many homebuyers put down 5% or less (PDF).

If you put less of your savings down, you’ll have more to put toward paying off your other debt. However, the less money you put down, the higher your monthly mortgage payments will likely be. Could a lower down payment be right for you? Maybe.

Consider two possible scenarios for a potential homebuyer who has a good credit score but also:

  • $5,000 gross monthly income
  • $25,600 in consumer debts (payments total $500 each month)
  • $250,000 home price
  • $57,600 in savings
  Scenario 1: 20% down Scenario 2: 10% down + $25,600 consumer debt payoff
Down payment 20% down = $50,000 10% down = $25,000
Closing costs $5,626.96 $5,710.29
Loan term 30 years 30 years
Rate and APR (annual percentage rate) 3.25% (3.31% APR)

NOTE: This is an illustration and not a quote for an actually available rate.
3.20% (3.43% APR)

NOTE: This is an illustration and not a quote for an actually available rate.
Private mortgage insurance (PMI)

NOTE: If you don’t put 20 percent down, you’ll need to pay PMI each month until you reach 20 percent equity)
N/A $76.88 per month
Total monthly mortgage payment $870.41 (does not include homeowners insurance and taxes, which vary in all cities and states) $973.05 (does not include homeowners insurance and taxes, which vary in all cities and states)
Total liabilities each month $870.41 mortgage payment + $500 consumer debt payment = $1370.41 $973.05 mortgage payment

 

In Scenario 2 above, putting 10% down and paying off the consumer debt in full saved $397.36 each month. However, a smaller down payment means taking out a larger mortgage and paying PMI, adding to overall costs over the life of the loan.

Every situation is different. Ask yourself what mortgage and down payment you can afford and feel confident about while still saving money and paying off debt.

Have questions?

Whether you’re just getting started or ready to take the next step, talk with an expert to guide you through the homebuying process.