Buying a home is a major step in your life. It’s an accomplishment less than 65% of Americans have achieved, so it’s something to proud of. Do you have everything in order that you need, though?
Credit card debt is a common problem, and most people realize that it can impact their ability to get a mortgage. How much credit card debt is okay if you’re buying a home? Here’s what you need to know.
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How Credit Card Debt Affects Your Mortgage
Before we get into the specifics of how much credit card debt is problematic, let’s look at why it matters.
Debt to Income Ratio
One of the key factors a mortgage lender will consider is your debt-to-income ratio or DTI. This is exactly what its name implies: a comparison between your debt and your income.
Lenders use this as a way to gauge how much of a mortgage payment you can afford. The more debt you have, the higher your monthly payments are toward those debts. That leaves less money to pay a mortgage.
Keep in mind that while lenders include your credit card debt in your DTI, they factor in your other debt too. That includes cash loans, car loans, student loans, and more.
Your credit score is a major factor in your mortgage application. It tells them how well they can trust that you’ll make your payments on time.
Outside of missed payments, the key way credit card debt affects your credit score is through your credit utilization ratio.
Credit card debt falls under the category of revolving credit. This means you have a certain amount of credit you can continually use, pay off, and use again.
It’s different from an installment loan, for instance, in which you use the money once and when you pay it off, the account is closed.
Your credit utilization ratio is the amount of your revolving credit that you’re currently using. The higher it is, the more it can lower your credit score.
How Much Credit Card Debt is Okay When Buying a House?
Now that you know how credit card debt affects your mortgage application, how much is too much? There is no magic number. For both DTI and credit utilization ratio, it depends on several factors.
Acceptable Debt to Income Ratio
A lender determines your DTI by first adding up the minimum monthly payments for all your debt. They divide that number by your gross monthly income. This gives you a percentage, which is your debt-to-income ratio.
Most lenders won’t offer you a mortgage if your DTI is 43% or higher. Some rare lenders will go up to 45%.
However, the lower your DTI is, the higher of a mortgage they’re likely to give you. A “good” DTI is considered anything below 36%.
When Credit Card Debt Affects Your Credit Score
Your other question may be, “how much credit card debt is enough to lower my credit score?”
As we mentioned above, the number you need to know is your credit utilization ration. To find this, start by adding up the credit limits of all your credit cards.
Next, add up the balances on all your credit cards. Divide that number by your total credit limit. This gives you a percentage, which is your credit utilization ratio.
When it comes to your credit score, the lower that utilization ratio is, the better. It doesn’t tend to lower your credit score until it reaches 30% or higher.
What to Do if Your Credit Card Debt is Too High to Buy a Home
If you have a DTI under 36% and a credit utilization ratio under 30%, you’re good to go. If not, what can you do to get into your dream home?
Increase Your Income
Your debt-to-income ratio is based on two numbers: your debt and your income. One of the fastest ways to improve it is to increase your income.
If you don’t want to change jobs or you aren’t able to, try getting a “side hustle.” You could join a part-time sales team or pick up some freelance work based on your skills.
An income boost does double duty toward your DTI. First, it raises your income so that if your debt stays the same, your DTI improves. If you use that income to pay down your debt, you can improve your DTI even more.
Get a Loan
If you have good credit but your credit card debt is high, it could be a good option to get a loan. Use that debt consolidation loan to pay down as much of your credit card debt as possible.
A personal loan with a lower interest rate than your credit cards can help you pay down your debt faster.
This also transfers your credit card debt from revolving credit to closed-end credit. That lowers your credit utilization ratio, improving your credit score.
Keep in mind that this is only a good option if a high utilization ratio is the top negative factor on your credit report. Applying for new credit more than twice in a year will hurt your credit score. Don’t take this route if you have other new credit accounts.
Request a Credit Limit Increase
Instead of seeking new credit, you could request a credit limit increase from your existing credit cards. This raises your total credit limit, which will lower your utilization ratio if your debt stays the same.
However, you should only do this if you have the will power not to fill up that new credit. If you get a credit limit and add to your debt, your utilization ratio will stay the same and it won’t improve your chances for a mortgage.
Getting Your Dream Home
Homeownership is a dream for countless Americans. It’s frustrating when something as minor as credit card debt holds you back from reaching that dream.
While there is no exact science, there are ways to know how much credit card debt is okay when you buy a home. Working out the calculations above can give you an idea of your chances with a mortgage lender.
If you want to take steps to lower your credit card debt, start by applying for a loan today.