How to Buy a House When You Have Too Much Debt

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When you fill out a mortgage application, lenders look for income to offset debt. If your monthly debt payments consume too much of your income, you may have a tough time qualifying for a home loan.

Underwriting, which is the decision-making of whether or not to grant credit, determines what your income is with supporting documentation like pay stubs, W-2s and tax returns. (It also looks at your credit scores to decide whether you qualify. You can get your two free credit scores, updated each month, on Credit.com.)

Fortunately, a lender may be willing to look at more than just your regular salary when it comes time to calculate your debt-to-income ratio. Here are various forms of income most mortgage banks will sign off on.

1. Annuities

If you’re eligible, you can purchase an annuity, a contract sold by a life insurance company that provides regular monthly income in return for an initial lump-sum deposit.

The income derived from this annuity will be used to determine how much mortgage and/or house you can qualify for. An annuity can be brand new — you need not have a long history of this income as long as it’s set to continue for the next 36 months or longer.

2. Social Security Income

If you’re eligible for Social Security, you might want to consider taking it early as this income can easily be used to help you qualify for a mortgage. You may be also able to “gross up” this income by up to 1.25%, depending on whether or not you pay taxes on it.

3. Notes Receivable 

Generally, you’ll need to earn income from a note receivable (a credit extended to a business) for at least 6 months for it to count on a mortgage application. Notes receivable income has to be based on the market rate and it’s the interest on the note that is used to determine your eligibility for your desired borrowed amount. For example, if you have a note receivable at 5.5% based on a principal balance at $50,000 that income would be $229.16 per month used for a mortgage.

4. Purchasing a Rental Property

If you are looking to purchase a rental property, you’re in luck. You can use projected fair market rents to qualify for its mortgage. Lenders will use up to 75% of gross market rents to offset the mortgage payment. In other words, because the renters are making the mortgage payment, you don’t need to earn as much to get a green light on your loan application.

5. Renting Your Current Home

If you are trying to buy a new primary residence, but don’t have enough income to support two mortgage payments, you can rent out the property. A rental agreement and tenant security deposit allows you to offset the mortgage payment on your current home to qualify for a mortgage on a new home. The concept is almost identical to purchasing a rental property, with the exception of needing to have a rental agreement in place for your current home.

6. Self-Employment Income

A history of self-employment income is required for it to count on your mortgage application. Generally, Schedule C Sole Proprietor income needs to be in place for at least 12 months in order for that income to count. Note: If you have been self-employed for the past two years and you had one bad year, followed by a good year, your income will be averaged by your lender.

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4 Credit Tips for Buying a Home

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This may come as a surprise, but you don’t need a perfect credit score to buy a home or get a mortgage.

In some cases, your credit just needs to be sufficient. Good, bad, ugly or indifferent, as long as your credit score matches the criteria of the mortgage size and property type you are looking for, you may be able to get financing.

Here’s a quick cheat sheet of the top three most commons mortgages and their basic credit score requirements.

  • Conventional loans. You generally need a credit score of 620. However, anyone with a 620-679 credit score should expect to pay higher interest rates and fees.
  • FHA loans. You’ll generally need a credit score of at least 600. There are lenders that do FHA Loans with credit scores as low as 580, but it’s going to come at a cost. Expect the lender to go through your file with a much finer-toothed comb if your score is at 620 or below. Conversely, if your credit score is 620 or higher, not only will you get better rates and fees, but you’ll also have an easier loan process.
  • Jumbo Loans. You’ll generally need a credit score of at least 680. You will also generally need at least 30% equity when buying or refinancing a home. A 700 or better score yields better rates and terms and requires less down (possibly as little as 20%).

Of course, a good credit score generally helps you net better terms and conditions. You can check two of your credit scores for free each month on Credit.com to see where you stand. If you have some credit challenges preventing you from getting a mortgage with competitive rates and fees, here are some strategies straight from a mortgage pro that could improve your situation.

1. Pay Down Debt/Rapid Re-Scoring

Some mortgage lenders have a credit doctor service, known as rapid re-scoring, available through their credit reporting company. This service allows them to run statistical credit modeling: the lender plugs in a certain credit score needed, an algorithm analyzes your complete credit portfolio and outlines what can be done to get you to that aforementioned threshold.

Oftentimes, high credit utilization (the amount of debt you are carrying versus your total available credit) is the culprit for a low score. In those instances, paying down certain credit accounts could make you more creditworthy — and mortgage eligible — within short period of time.

2. Time

If buying a house is a longer-term goal, time can be your friend. Credit history is a large component of a healthy credit score. Make your payments on time, keep the amount of debt you are carrying low and avoid late payments of any kind. These smart spending habits show that you are responsible with your obligations and will bolster your credit score eventually.

3. Quit or Resolve Disputes

In order to get a mortgage, you generally cannot have any accounts in dispute on your credit reports. At the same time, simply removing a dispute from your credit report can make your credit score drop. The reason? Credit scoring models generally ignore information being disputed, like an account with a late payment, which would otherwise hurt your credit score.

In order to circumvent these problems, work to resolve any disputes. (You can find more about getting errors off of your credit reports here.) You can also consider handling any issue you may have with a lender directly in lieu of filing a formal dispute with the credit bureaus. Here are some tips for negotiating with creditors.

4. Put More Money Down

Putting more money down to buy a home could put you in an entirely different mortgage category and help you bypass certain credit scoring problems.

Remember, if you have been told “no” by a bank or lender, you owe it to yourself to get a second or third opinion. What’s more, your credit score could improve from month to month, depending on what’s holding you back, so keep an eye on it in the meantime.

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