Home Buyers: Reduce Your Credit Card Debt Now

Article Summary: If you are planning to buy a home in the near future, you should reduce your credit card debt as much as possible. There are two reasons for this, and they are both explained below.

There are thousands of articles online that offer tips for reducing debt. But that’s not what this article is about. Instead of focusing on the “how” factor, I’ll be addressing the “why.” Specifically, I’m going to explain why you should reduce your credit card debt before applying for a mortgage. This article is intended for first-time home buyers who plan to purchase a home within the next 6 to 12 months.

How Credit Card Debt Affects Home Buyers

Why do home buyers need to be concerned with the amount of credit card debt they have? How does it even relate to the home buying process at all?

Well, it has everything to do with the mortgage approval process. In fact, having too much debt can hurt you in two ways. It can lower your credit score, and it can also hurt your debt-to-income ratio.

Lenders will look at both of these things when reviewing you for a loan. They will check your credit, scrutinize the amount of debt you are carrying, and measure your current income compared to the loan amount you seek.

So it’s in your best interest to take credit card debt seriously, and to make every effort to reduce it before you apply for a loan. Let’s look at these two problems individually, and in more detail:

The Credit Score Factor

I probably don’t need to tell you about the connection between credit scores and mortgage loans. Here’s the short version. When you apply for a home loan, the lender will review every aspect of your financial background. Your credit score is a big part of this review process. If you have a high score, you’ll be more likely to get approved for the loan — and you’ll also get a better interest rate on the loan. But if your score is too low, you might get turned down altogether.

What does this have to do with credit card debt, you ask? Good question. If your card balances are extremely high, relative to your card limits, it will actually drag down your credit score. In fact, the “credit utilization ratio” (as it’s known) is one of the top two factors that influence your score. So if you can reduce the amount of credit card debt you currently have, you will likely increase your score at the same time. This will help you get approved for a mortgage loan, and it will also help you qualify for the lender’s best rates.

Your Debt-to-Income Ratio

I’ve just given you some pretty good motivation for reducing your credit card debt before applying for a loan. Here’s another incentive for you. If your overall debt is too high relative to your income, you will have problems getting approved for a loan. This is known as the debt-to-income ratio — a comparison between the amount of money you pay toward your debts each month, and the amount of money you earn.

The more debt you are carrying relative to your net income, the lower your chances for mortgage approval. That’s another good reason to reduce your credit card debt before trying to buy a home. If you’re carrying too much, it can drag down your credit score as well as your debt-to-income ratio. And both of these things will make it harder to get approved for a mortgage. Call it a double whammy.

Where to Find Help

There are plenty of companies out there that claim to help people reduce their credit card debt “quickly and easily.” But the truth of the matter is this. The only person who can pay down your debts is you. Unless, of course, you suddenly encounter a mysterious benefactor who is willing to pay off all your bills. But here in the real world, it’s up to the individual to reduce his or her own debts. Most of the companies that claim to have this magical ability are scams. So you should avoid them altogether.

With that being said, there are some legitimate sources of help available. In particular, there are some nonprofit debt counselors who can help you set up a payment plan to reduce your credit card debt before buying a home. Here are two good examples:

• National Foundation for Credit Counseling (www.nfcc.org)
• Springboard Nonprofit Consumer Counseling (www.credit.org)

The two organizations listed above are both nonprofits. They offer free and low-cost counseling for people who are trying to manage their debt. If you can reduce your balances on your own, great! If you need help, check out the two websites listed above.

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