Earlier in the year, we covered how your debt to income ratio is a crucial component in calculating the amount of home you can truly afford, as well as your chances for approval with a lower interest rate.
Paying down debt to reduce your debt to income ratio is important. What many don’t understand is that there are some best practices to consider.
Some might think paying off debts that carry the highest interest rates first is a good approach. While it is always a good idea to not carry balances with high interest, when applying for a home loan, you may want to consider prioritizing paying off debts that can improve your borrowing power.
What does that mean? Your debts that carry higher monthly payments are the larger consideration in calculating your debt to income ratio.
Let’s say you have two main debts that will be considered when applying for a mortgage.
1) Your car loan.
- Payment: $400/month
- Interest Rate: 0%
- Remaining Balance: $10,000
2) A credit card.
- Payment: $200/month
- Interest Rate: 16.99%
- Remaining Balance: $5,000
While most might think paying off the credit card in full would better your chances, the truth is that paying off the car loan would free up $400 per month in borrowing ability for a mortgage. This translates to about $40,000 in home-buying power.
If you’re planning to purchase a home and aren’t sure what to pay first to optimize your financial situation for borrowing, reach out to us at 877-892-8222. With the knowledge of your current debt and income, we can run various scenarios including what you qualify for now with your current obligations and what you could qualify for if those liabilities were paid off.
Our team can give you guidance for which to take care of first to put you on the path to home ownership.