Many people we talk to who had credit problems – have gone to an all “Cash” economy – meaning they don’t use credit at all any longer. We totally understand that theory, but we feel that the better program involves having SOME credit active. And today, that generally means that you need some revolving credit. Trying to figure out how much debt should you carry in order to have the BEST credit score is the real question most folks have.
Well, obviously, you don’t want to have more than you can pay, but seriously, there are other things you should look at too – like what KIND of debt do you have? Is it “Good Debt” or “Bad Debt?” Do you meet the minimum credit scores required to buy a home in 2013? With the changes by NCHFA this spring, most borrowers will need a 640 minimum credit score.
Good Debt is generally looked at as an Investment – a Car payment, a House Payment, that debt for items that should generally be considered an ASSET are in the Good Debt column. BAD Debt traditionally has been seen as revolving credit card debt. The items we should probably be paying CASH for. However, the way the Credit Models currently work – we all need some credit card debt in order to get the very best scores. If you can’t get a credit card right now, look into a Secured Credit Card. There’s generally a fee for the first year of having these cards, but it really is worth it.
How do you know if you have too much Debt to buy a house? There’s a formula! To calculate your debt ratios (this is exactly what we do when we are looking at qualifying you for a mortgage) simply add up the amount you spend each month on debt and divide it by your total monthly income. Then, multiply that number by 100 – which will give you your Debt to Income Ratio. For example, let’s assume your gross income (before taxes) is $3,000 a month. Let’s also assume you spend $300 on credit card payments and $450 for your cars. Your ratio calculation would be $750 / $3,000 = 0.25. Multiply that by 100 for a debt-income-ratio of 25%.
If you are trying to buy a house, the maximum TOTAL debt ratio will not be allowed above 50%, unless you are putting way more than 20% down on the house. If you are getting a government loan (USDA Home Loan, VA Loan or FHA) we generally think the maximum the system will take is 42% – but if you have a really high credit score, we’ve seen USDA Home Loans accepted with a total debt ratio as high as 48% this year!
When it comes to debt, especially if you are trying to buy a house, the lower the debt you have, the better. Again, assuming your gross monthly income is $3000, than at 40% as a total debt ratio the most your TOTAL payments (including your house payment) can be is $1200. So, you deduct our $750 a month in debt from $1200… and you realize you would not be buying a very big house.
If you are considering a mortgage loan – please let Steve and Eleanor Thorne in Cary, NC – We’ll help you with qualifying! 919-649-5058