Is it better to reduce monthly payments or total debt before applying for a mortgage?

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I went to try to get an idea from my local Credit Union of how much of a mortgage I could pre-approve for, and they the answer was far less than I expected. As she was calculating our totals she said that our monthly debt was bringing down our loan amount possibilities. My question is should I focus on a consolidation loan to reduce monthly payments or throw money at the problem and try to reduce my total debt amount, even though I can not afford to totally remove any actual bills.

  1. Reply
    July 21, 2011 at 12:25 am

    Chris you need to reduce your “long term” debt. Those items that will typically take you more than 6 months to pay off. Start with the smallest of these and work your way down the list. In today’s lending rules it’s difficult to know from one day to the next what lenders can or can’t do. But it would be in your best interest in the long run, to have less debt before you buy a home. Keep in mind also, so you’ve accomplished your goal of reducing your debt load, the amount your are approved for does not mean you have to spend it all. If you find a home priced less than what you are qualified for, is better. So maybe consider what monthly payment your comfortable with now and try to stay close to that. After you buy a house, you ARE going to have expenses, some to just set up utilities, but mostly you are going to want to “nest” as I like to put it. Make the home yours. And with that thought comes buying all kinds of things and again finding yourself in debt. So be thoughtful about your actual needs and know that home ownership is a long term relationship and one that is ever changing. Best of luck!

  2. Reply
    July 21, 2011 at 1:00 am

    Your credit union is looking at your debt-to-income (D/I) ratio. In many reputable banks and credit unions, loan officers prefer that you not carry more than 25% of your gross income in mortgage debt, and no more than 36% of your gross income in total debt. So what your credit union approved you for is probably the mortgage amount that would keep you at 36% or less of your gross (pre-tax) income going toward debts of any kind, including your mortgage.

    The best things to do:

    1. Get that debt off of your shoulders. I would stay away from consolidation companies. Just throw everything you’ve got at the smallest of your debts and pay the minimum monthly amount on all the rest. Soon, that smallest debt will be paid off, and you can move up to the next-lowest debt. You’ll throw everything you’ve got at it (which will be easier now because that smallest debt is paid off) until it’s paid in full. This is what Dave Ramsey calls the “debt snowball.” It works, if you can stay disciplined and limit discretionary spending. The less going out to dinner, the movies, etc. you do, the quicker you can get these debts paid off.

    2. Increase your down payment amount. Once you’ve got your debt eliminated or at least cut down by half, start saving some money in a savings account or high-yield certificate of deposit at your credit union. The bigger your down payment, the more house you can afford. Your credit union probably prefers that you pay at least 20% of the total loan amount as a down payment, in addition to any loan fees.

    Finally, the first answer’s point is very valid: Ideally, you want to buy LESS house than your bank tells you you’re capable of buying. Be conservative in setting the maximum price you’re willing to spend on a house. Say your bank approves you for a $ 250,000 loan after you get everything straightened out with your debts and have a little more down payment money saved. Setting your maximum price at $ 200,000 or $ 225,000 will make the payments more manageable in the future, should you get laid off, take a pay cut, get sick, etc. If you live life on the edge (i.e. carrying lots of debt just because the bank says you’re able to do it,) eventually, you’re bound to fall off!

  3. Reply
    July 21, 2011 at 1:11 am

    Yes, because you will get a better interest rate.

  4. Reply
    July 21, 2011 at 1:34 am

    The credit system is one that works well for banks and lenders as a way to prevent themselves from dishing out loans and not getting anything back in return. However it is not a system that is particularly fair to the customers and from their perspective it is poorly designed.

    To get bad credit an individual will generally have fairly low funds in the first place. This will mean that they are late paying back loans, miss credit card payments, allow their cheques and debits to bounce or go below their overdraft. In cases where an individual is supporting a family or paying for a home but has insufficient funds, all of these things are fairly unavoidable.

  5. Reply
    July 21, 2011 at 2:31 am

    One of the best things you can do prior to applying for a mortgage is to reduce how much you owe, as well as cleaning up your credit report. Consolidating your debt might help, but in the end, you will still have about the same amount of debt, which is the more important factor.

    Also, don’t close out your credit lines once you pay them off, instead keep them open, which will improve the ration of debt to credit.

  6. Reply
    Jeanne R
    July 21, 2011 at 2:45 am

    What keeps most people in debt is the fact that they keep spending more money than they make. They look at the “monthly payments” instead of the total debt loan that they are carrying. People need to stop spending now and concentrate on becoming debt free. Please do not consolidate or use a debt reduction company . It is not free, they will lower your payments by increasing the length of time until you are debt free, and you will take a hit on your credit score. Or they negotiate your debt down after telling you not to pay for awhile adding another hit to your credit score. If you want to buy a house “soon”, it is better to get the debt paid off, not “consolidated”. Consolidation does not change your amount of debt (except that your debt goes higher because of the fees they charge) so your debt to income ratio will not improve. Student loans are the only debt that can garnish your wages for non payment without taking you to court first. When you do buy a house, keep the payment around 25% of your take home income, 28% at the most and only get a fixed rate loan preferably for 15 years, 20 years at most. Many lenders are now selling 40 year loans as well as 30 year loans. Believe me, you do not want to be paying on your house for the next 30 years, 15 is enough. Most lending institutions will tell you that 33% or 35% is fine, but that is really hard to live with and you run the risk of becoming “house poor” and working just to feed the mortgage.

    Just list the debts out on a piece of paper or a spreadsheet and follow the plan. If you work the plan, the plan will work for you.

    A. Have a garage sale and sell anything that you no longer need or want.

    B.Get a temporary part time job, if you have one, get another.

    Here is a plan that can help you. If you work the plan, the plan will work for you:
    1. Make a budget. Make the budget a week before you get paid. A budget is not a punishment! It is a tool which will free you from ever having to worry about money again. Put everything in your budget. Especially those annual, biannual, or quarterly bills like car registration, insurance, etc. Give every dollar you are going to bring home the name of where it is going. Add an “emergency fund” category to your budget for 25 dollars and save up until you have 1000-1250 dollars. Your emergency fund will help keep you from getting into new debt because of an emergency. If you can, set up a direct transfer to a savings account for your emergency fund. That way it moves automatically and you don’t even have to worry about it. You must cut your spending and live on less than you make.

    2.First get current on all of you debts and make no more late payments. Stop using your credit cards immediately. Do not take on any more debt. Credit cards are like quicksand only the death is much slower. Make a list of all of your debts in order of highest interest rate to lowest interest. Use cash only for your spending from now on.

    3.Pay the minimum due on all of your debts and then put your extra money towards paying off the highest interest one first. After you get that one paid off, you put the money you were paying on debt #1 (the minimum payment and the extra payment) towards debt #2. That will pay debt #2 off faster. When that is paid off, you put all three payments towards card #3 and that one will be paid off pretty quickly. As an example:

    To start :
    Debt #1 (highest interest): minimum payment+ extra payment
    Debt #2 (middle interest): minimum payment
    Debt #3(lowest interest): minimum payment

    Debt #1: paid off
    Debt #2: minimum payment from Debt #1+ Minimum payment from Debt #2 +extra payment
    Debt #3: minimum payment

    Debt #1: paid off
    Debt #2: paid off
    Debt #3:Minimum payment from card #1+ minimum payment from Debt #2+ minimum payment from Debt #3+ extra payment.

    That way, you will get them all paid off, on time, and pay the least interest. It will also help towards rebuilding your credit since you will no longer have any late payments. This works no matter how many different debts you may have.

    4. After you get all of your debts paid off, add to your emergency fund until you have 6-12 months of income saved up. Put that emergency fund money into a liquid money market fund or into a Bank of America no-risk CD so that if you need the money you can take it out without penalty.

    5a. When you have your emergency fund in place, add a category for “fun” to your budget. Save for a holiday, a vacation, a big screen, or dinners out, whatever goal you want. Remember to enjoy your life.

    5b. When you have your emergency fund in place, start saving for your retirement. Join the 401(k) plan at work and contribute the maximum. Your employer probably matches at least part of your contribution so why give up free money? Open a Roth IRA and contribute the maximum on a monthly basis. If you start saving for your retirement now, you will probably retire a millionaire.

    5c. When you have your emergency

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