by Christy Bieber | June 23, 2021
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You absolutely can't afford to make this error before applying for a mortgage.
When you're getting ready to apply for a mortgage to purchase a home (or to refinance your current loan), it's important not to do anything that could hurt your chances of qualifying for a home loan at a competitive rate.
Unfortunately, there's one mistake that far too many people inadvertently make before getting a home loan: Taking on new debt. And it's a mistake that could actually hurt their application in two key ways.
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When you're considering getting a mortgage loan, going into debt is a common and serious mistake many borrowers make. Would-be homeowners may borrow:
And it's crucial to avoid this error in order to prevent double-damage to your chances of getting approved for a loan.
See, your credit score and your debt-to-income ratio are two of the most important factors that mortgage lenders look at during the loan approval process. And going into debt will hurt both of them.
Your debt-to-income (DTI) ratio compares the amount of your monthly debt payments to the amount of your monthly income. When you take on new debt, your required monthly payments increase because you have to pay back the loan. Your debt-to-income ratio will be higher as a result of your new borrowing.
If your debt-to-income ratio climbs too high, you may not get approved for a loan at all. But even increasing it slightly could make you seem to be a more risky borrower. This could result in a lender charging you a higher interest rate, thus making your mortgage more expensive.
Your credit score could also be impacted by taking on new debt. First, if you've applied for a brand new loan, you'll get a new inquiry on your credit report. Too many inquiries can reduce your credit score. Your new debt will also reduce the average age of your credit history. A shorter average credit age can also cause your score to drop.
Even if you don't apply for brand new credit, going deeper into debt on your current credit cards could also hurt you. That's because your credit utilization ratio is a key factor in determining your score. That ratio looks at the credit used versus credit available -- and a lower ratio is preferred. Charging more on your cards creates a higher ratio, thus potentially lowering your credit score.
Since your score could be lowered in several ways by taking on new debt and new borrowing would leave you with a higher debt-to-income ratio, you'd be applying for a mortgage at a serious disadvantage. A low score and a high DTI are the opposite of what mortgage lenders look for, and you'll almost assuredly be looking at a higher interest rate -- if you get approved to borrow at all.
Your mortgage loan will probably be the biggest debt you take on in your lifetime. It can be a very costly debt to repay due to the amount borrowed and long payoff time. The last thing you want to do is limit your choice of lenders or end up paying a higher rate. Steer clear of taking on any new debt in the months leading up to applying for your loan to ensure that doesn't happen.
Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.
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