First-Time Home Buyer's Quick Guide to Debt Consolidation

You can still buy a home when you're in debt
Last updated Sep 14, 2020 | By Miranda Marquit

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When you have debt, it can feel like you’ll never be able to do anything financially again — at least until you’ve paid off the obligation.

However, that’s not always the case. In fact, it’s possible to buy a home with debt. First time home buyer debt consolidation is a possibility, even if you think you might have too much debt. The key is in understanding how debt consolidation works and its impact on your chances of getting approved for a mortgage.

Here’s what you need to know about buying an affordable home and how to get a loan when you’ve got debt already.

Can You Consolidate Debt Into a Home Loan?

In many cases, the interest rate you get on a mortgage is lower than what you’ll see with other types of debt. That’s because your home secures the loan, and can be repossessed if you stop making payments. For some consumers, it can feel like a good idea to roll some of their debt into a home loan.

However, it’s not as straightforward as you might think. First, mortgage lenders aren’t likely to loan you more money than the house is worth. Instead, you’ll need a bigger down payment in order to consolidate some of your debt into a home loan.

For example, if you want to buy a home that costs $180,000, your mortgage lender might only be willing to loan you up to 97 percent of the price, or $174,600. In order to meet that minimum, you need a down payment of $5,400. Say you have $10,000 you can put down. You have room enough to consolidate $4,600 into your mortgage.

Lenders might also require you to have very good credit in order to add extra debt to your mortgage. Talk to your lender about the possibility, letting them know how much debt you have. If you’re having trouble meeting the debt-to-income (DTI) ratio requirements, rolling the debt into the home loan can help you qualify for the home.

Can You Consolidate a Car Loan Into Your Mortgage?

When I went to buy a home, one of the issues I ran into was that the monthly car payment put my DTI over the top for qualification. In order to keep my DTI in line with underwriting requirements, something had to be done about the car payment.

In order to make it work, I financed extra in the home loan to pay off the car loan. My parents offered a gift for part of the down payment, making the deal more affordable. In order to have someone else cover part of the down payment, it must be a gift — and usually from a relative.

The extra amount in the loan meant cash to pay off the car, reducing my overall DTI, and I was able to buy the house.

Can You Roll Credit Card Debt Into Your Mortgage?

As with other types of first time home buyer debt consolidation, it’s possible to use your mortgage to pay off some of your credit card debt. However, you might need a bigger down payment for it to work. Additionally, the underwriters will want to carefully look at your payment history to make sure you’ve been consistent in making regular, on-time payments.

This isn’t always the best idea, though, because your credit card debt is unsecured. If you miss payments, your creditors can sue you and try other ways to collect on the debt, but they can’t seize your home. If you roll credit card debt into a mortgage, though, things change. If the higher payment isn’t doable, you’ve now turned that unsecured debt into secured debt and put your home at risk.

In some cases, if you have enough extra money to make a bigger down payment, you’re often better off just directly paying down your high-interest credit card debt instead of including it with your home loan.

Buying a House When You’re in Debt

Debt-to-income ratio has been mentioned above, and that’s for one very good reason: when you talk first time home buyer debt consolidation, it’s the key to the equation.

DTI represents the amount of your monthly income going toward debt payments. Let’s say you have the following monthly payments:

  • Car loan A: $350
  • Car loan B: $200
  • Credit card A minimum: $160
  • Credit card B minimum: $105
  • Credit card C minimum: $75
  • Student loan A: $300
  • Student loan B: $250

All those payments amount to $1,440 each month. Now, let’s say you make $4,200 each month. Your DTI is 34 percent — and that’s before your housing debt is in the picture.

Many typical mortgage guidelines allow you to have up to 43 percent DTI when buying a home, including your mortgage. So, if you’re looking at a mortgage payment of $700 a month, that will push your total debt up to $2,140, or 51 percent DTI. It’s going to be hard to qualify with those numbers.

When buying a home, you need to figure out how to get rid of some of that debt. Part of it can be using a bigger down payment to make room to roll some of the debt into your home loan, getting rid of a loan (and a payment).

Another option is first time home buyer debt consolidation before you make your move.

Can You Buy a House After Debt Consolidation?

With the right planning, you can actually consolidate your debt before making your mortgage move. The key is in getting a debt consolidation loan that lowers your monthly payments so that your DTI is acceptable to lenders.

Your larger loan has lower payments because you get a longer term. Say you borrow $19,500 for five years — enough to finish paying off your cars and consolidate your credit card debt. Using a debt repayment calculator, you find that you can save $500 a month.

Subtract that $500 from the $2,140 you were at before, and now your DTI is down to 39%, which is in the acceptable range for many lenders. If you can refinance and consolidate your student loans, you might be able to get that DTI even lower.

Buying a house after debt consolidation requires planning, though. Your credit score might take an initial hit, so you might need a few months to recover. Consider consolidating your debt at least six months before you apply for your mortgage. Don’t close your credit cards. Instead, put them away so you aren’t using them and running them up again. You want to keep a good debt utilization score.

With a little planning, it’s possible to buy a home even when you have debt. Run the numbers and see if consolidating can help you bring down your DTI and get into your first home.

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