Buying a dream home can be both exciting and terrifying. It can be especially worrisome if you have concerns about managing debt or qualifying for a mortgage. You can still dream of owning a home, even if you have large amounts of debt. The secret lies in practicing good debt management skills and keeping an eye on your credit scores.
Check Your Credit Score
When preparing, you should focus first on your credit score. The credit score is a number that credit agencies generate to represent your habits and history. Lenders use the credit score to judge how much risk they will have when they give you money for a loan.
High scores reflect people who manage finances well. When you increase your score, you increase the chance of creditors offering you larger loans with lower interest rates. Although the specifics depend on your lender, there’s generally a minimum credit score to qualify for certain mortgages. For example, you need to have a score of 620 to qualify for a conventional loan, but an FHA loan with a large down payment can be secured with a score as low as 500. These minimums change regularly, so ask a mortgage broker for the current values when you start your prequalification process.
Tip: A mortgage broker can help you check your credit and get you a prequalification letter, so! Find a good mortgage broker and reach out to them early in the planning process.
Repair Your Credit
If your score is low, you can improve your credit. This crucial financial measure is based on five factors, with payment history and credit utilization being the two most influential pieces. Improve your score by paying your bills on time and using no more than 30% of your available credit. Have a mix of different types of accounts, avoid opening new lines of credit, and hold on to your accounts for long periods of time.
The following three tips are important to note when improving your credit score: Firstly, it’s not a good idea to make drastic changes to your credit report immediately before applying for a mortgage. Secondly, paying off debts completely actually drops your score a bit, so you should aim for “low balances” and not “zero balances.” Lastly, new debts and hard inquiries into your credit can act as red flags to underwriters.
Make a Budget
According to recent surveys, three in five Americans don’t know their own monthly expenses. Understanding your monthly finances and having control over them improves your chances of securing a mortgage.
A thorough budget will include every expense. Seeing a list of your spending habits will make it easier for you to visually determine where you can cut costs. When in doubt, underestimate your income and overestimate expenses to ensure you have a buffer in your budget.
In addition to your credit score, banks use your debt-to-income ratio to determine if you can afford a home. The Consumer Financial Protection Bureau states that your debt-to-income ratio cannot exceed 43%.
If you are having difficulty lowering your debts, try offsetting them by starting a side business. Starting a side business can generate extra income, but it is certainly not a get-rich-quick option. Businesses take time to start generating serious income. So, try to cut costs before looking at side hussles. For a good book on making a profitable business and on cutting costs, check out “Profit First” by Mike Michalowicsz. These tools can be used on personal budgets as well as business budgets, so its worth a read even if you are not starting a business.
Finances can be hard to manage when you have lots of payments. Save money and stress by consolidating your debts into one easy payment. Also, when you have just one due date each month, it is harder to miss the payment!
All unsecured debt can be consolidated. Consider this if you’re not ready to move for another year and can build your credit up over time.
Debt can often feel suffocating, but you can still secure a mortgage if you establish good practices like budgeting, low spending, and proper income management. Keep these things in mind, and you’ll be ready for your dream home within the year.