If you’re planning to buy a home with a loan, you need to be aware that lenders like it when you have low overall debt, including credit card debt. The reason behind this is that you’re less likely to be a credit risk.
On the other hand, high debt makes lenders wary of granting you a loan because they perceive it to be risky. Even if you manage to get a loan, you’d be receiving it at a higher interest rate.
When it comes to home loans in the US in 2022, your credit card debt should not exceed 10% of your after-tax income and your credit utilization should be below or at 30% of your total available credit limit if you want to get a home loan easily and at reasonable interest rates. These two metrics have been discussed below.
1- Credit Card Debt Ratio
Generally, credit card debt that does not exceed 10% of your net-income is okay when it comes to buying a home in the US with reasonable interest rates in 2022. It is determined by something called credit card debt ratio. It is your credit card bill divided by your after-tax income.
If your net income is $6000 and your credit bill for the same period is $600, you’re well within the 10% safe-zone.
2- Credit Utilization
Credit Utilization refers to the amount of credit you’re spending relative to the total credit limit you have available. It’s obtained by dividing the credit you’re using, by your credit limit. It should not exceed 30%. Beyond that, you’d be damaging not only your credit score but also your prospects for getting loans more easily and at cheaper interest rates.
For instance, if your total credit limit is $3000 and the credit you’re using is $900 for the same period, you’re within the safe range. Exceeding this range would reflect negatively in your credit reports. A high credit utilization basically shows poor financial management and too much reliance on debt.
Should you be debt-free Before Buying a House
Most people think being debt-free plays to their advantage when getting a loan from creditors. However, this is not necessarily the case. What your credit report needs to show is that you have a good credit score which you may or may not have if you’re debt-free.
What your credit report needs to reflect is that you’re not over-dependent on credit and can manage your debt efficiently. Timely debt-payments carry the most significant positive effect for your credit value, accounting for 35% in your credit score.
Then comes credit utilization, that is, keeping your credit debt at 30% of your credit limit. This metric is used to reflect your credit-dependency. Having a mixture of debts like loans, mortgages, credit card debt etc. increase your credit score by 10% in what is called, the Credit-Mix.
Finally, your overall debt including credit card debt, loans, mortgages etc should not exceed 35% of your income. It’s measured in a metric called Debt to Income Ratio.
A good credit report is incredibly important in increasing the likelihood of you securing a loan and that too at a cheaper interest rate. So, having a credit score that reflects a good mixture of different debts, history of timely debt payments and no debt over-dependence could play out even better than being debt-free when it comes to getting a loan for a house.
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