How Credit Cards and High Debt Ratios Can Keep You From Buying Your Dream Home

We all love to spend money, right?  That’s what it’s for… to spend!  Clothes, cars, etc.  Why work so hard if you can’t enjoy it?  But there’s peril in this if you’re not careful. 

When it comes to buying a home, there are certain factors lenders look at to determine what kind of “risk” you are to them for paying it back.  Two of these factors are effected by your spending habits.  They are called “Debt Ratios”. 

Banks always look at the worst case scenarios when they consider loaning money to someone, so even though you may think every thing is fine, they are thinking about “what if’s” like . . . What if you lose your job . . . What if you get severely ill and can’t work . . . and other morbid and depressing possibilities . . .

So, it’s important to manage your Debt Ratios if you want to get the best loan at the best rate from the lender. 

There are two types of “Debt Ratios” you need to watch out for:

The First is how much you’ve charged up your credit cards and other loans.  If your credit cards have more than a 33% balance (e.g. you owe more than $333 on a card with a $1000 limit) it begins to adversely effect your credit score.  It doesn’t matter if you make the payments on time.  If your credit score goes down, you pay a higher rate for your loan which means higher payments on the same amount of money.

Second, if your total debt to income ratio is too high, it effects your “affordability” or how much the lender is willing to give you for a home loan as well as your credit score.  (So if you make $60,000 a year ($5000/month) and you have debt payments - not including rent or mortgage payments - of $20,000 a year ($1,666/month) (33%), the bank will see you as a higher risk and charge you a higher rate or not give you a loan at all).

Again, it doesn’t matter what YOU think you can afford now or in perfect conditions, the bank is ALWAYS thinking worst case scenarios.  So here are a few things you can do to keep your “Debt Ratios” in check:

Pay more than the minimum payments on your credit cards and other installment debts when you can.  The minimum payments are set up in most situations to keep you in debt and reduce the “principal” or actual amount owed very little.  Paying more will help get the principal amount reduced faster and save you money as well.  You can pay an extra payment any time, pay any amount any time etc.  The interest calculations will automatically be adjusted by the lender and the more you pay on the principal, the less interest money you will pay.

Pay cash for things when you can.  Don’t use your cards for everything.  Discipline yourself to save up for a new big ticket item instead of just charging it.

Avoid buying those consumer items when you can.  Ask yourself if you really NEED that new big screen TV.

In the end, you’ll be better off.  For every consumer dollar spent on quickly depreciating items, like TVs for example, you cost yourself interest dollars on that purchase, the lost value of that item as time goes on as well as potentially lowering your credit score to a point where EVERYTHING costs you more in the form of higher rates on future loans.