Living the American Dream While in Debt
Debt and the American Dream
Once you achieve the American Dream, you’ve made it, right? Society says you must have 2.5 kids and a home with a white picket fence to achieve this dream. If you’re in debt, this ideal American life may seem impossible to achieve, which can be discouraging.
How Important is Money to Achieving the American Dream?
Buying a house is one of the more difficult achievements, especially if you already have a large amount of unsecured debt, but that doesn’t mean it’s completely out of reach. Debt and the American Dream often go hand in hand, so it’s still completely possible to buy a house even if you’re already in debt.
Even if you currently have too much debt to get a mortgage approved, these tips will get you closer to a home of your own:
Know Your Debt-to-Income Ratio
It’s important to be aware of your debt-to-income ratio because many lenders use this percentage when making credit decisions which could impact the interest rate you receive.
A debt-to-income ratio is your monthly debt payments as a percentage to your monthly income. Lenders focus on this ratio when deciding whether you have enough money to cover your living expenses plus your debt payments. If you are married and will be applying for the loan together, you should add together both of your incomes.
For example, if your monthly debts total $2,000 and your gross monthly income is $6,000, then your debt-to-income ratio is 30%. Lenders prefer your ratio to be below 40%. If your ratio is above 40%, you should consider paying off more debt before taking on a mortgage anyway. A high ratio does not look great to lenders, and your finances most likely won’t be able to manage an added obligation.
Lenders typically want no more than 28% of your gross monthly income to go toward your housing expenses, including your mortgage payment, property taxes, and insurance. Once you add in monthly payments on other debt, the total shouldn’t exceed 36% of your gross income.
Lower Your Debt-to-Income Ratio
The higher your debt-to-income ratio, the more likely you are to struggle while qualifying for a mortgage and making your mortgage payments each month. A high debt-to-income ratio can severely hinder your efforts in achieving the American Dream.
There are several ways to lower your debt-to-income ratio:
- Avoid taking on more credit card debt.
- Don’t make any big purchases on credit before buying your home.
- Try to pay off as much debt as possible before applying for a mortgage.
- Get a raise at work or pick up another source of income.
In most cases, lenders won’t include installment debts like car or student loan payments as part of your debt-to-income ratio, so long as you only have a few months left of payments.
Save For a Down Payment
You may put off buying a home because you have heard that you need will need to put 20% down. Although that is the recommended percentage, it is not mandatory. For a conventional mortgage you usually need to put down at least 5%. Don’t get discouraged if you will never be able to put 20% down on a home within this lifetime. There are other options.
However, it’s important to remember that the more money you do put down, the better your interest rate will be. You can use up to $10,000 of an IRA, penalty-free, to purchase your first home. If you have a 401(k), you may also be able to borrow money from your account and pay it back over time. However, this is not the best option available because it will affect your retirement.
Be Aware of Your Credit Score
If you have poor credit, you may have to take some time to build your credit back up before purchasing a forever home. Keeping your credit card information secure, checking your statements often, and regularly running free credit checks can save you time and stress, especially on a big purchase like a house.
Although credit expectations vary based on the lender, the most commonly followed is the FICO score model is as follows:
- Excellent: above 750
- Good: 700 to 749
- Fair: 650 to 699
- Poor: 600 to 649
- Bad: below 600
Creditors likely won’t offer mortgage loans for a credit score below 620, but that number is continuously rising. Even if you are approved for a loan with a bad credit score, it may be the better option to prolong your plan of buying a house in favor of taking the time to build your credit. An approved loan with a lower credit score will result in a mass amount of interest.
Keep in mind that lenders will look at your income, assets, credit profile and employment, among other documents, when deciding whether to offer you a mortgage and at what rate they might offer it.
Get Pre-Approved for a Mortgage
Many people find the home they want and then apply for a mortgage. Do the opposite if you want a better chance of getting the home of your dreams. Get pre-approved with a lender before beginning your search for a permanent home—it will also let you know how much you can actually afford.
Make Money from Your Assets
If you’re worried about being able to make your mortgage payment each month, consider other options. A popular choice is renting out a room or a basement of your new home to help pay off the loan. Having someone pay you rent each month gives you an additional income and extra money to pay off your debts.
Although this is a useful way to make some extra cash, don’t rely on this option alone. It is important that you can pay your entire mortgage payment between tenants and when you cannot find someone to rent the space. You should also create a lease to avoid the surprise of a tenant suddenly moving out.
Consolidate Credit Card Debt with a Personal Loan
Paying off your credit card debt is the best thing to do before applying for a mortgage loan. If that is not an option, consolidate your credit card debt into a single personal loan at a lower interest rate than your current credit card interest rate.
A personal loan is another option that can save you interest expenses over the repayment period. Credit cards, however, are revolving loans that have no fixed repayment term. Therefore, when you swap credit card debt for a personal loan, you can lower your credit utilization and also diversify your debt types. An experienced debt settlement company can help you with this task.
New Era Debt Solutions has settled more than $275,000,000 dollars of debt since 1999 and wants you to be our next success story. If you need assistance achieving financial freedom, contact one of our friendly counselors at New Era Debt Solutions to learn more about finding the debt relief option that best fits your needs and budget. Our counselors are with you every step of the way.
