Getting a Mortgage While in a Debt Management Program

As rosy as the housing market appears, aspiring home buyers still face obstacles. Far too many people misuse credit cards and become mired in debt, while others struggle with unexpected medical bills that play havoc with their budgets.

Rising consumer debt can damage creditworthiness and lower credit scores, making it more difficult for some borrowers to find an affordable home loan. If you want to buy a house but have a debt problem, you should consider credit counseling and possibly a debt management program. Lowering your debt and learning to better manage money can make a big difference when you’re ready to apply for a mortgage.

Credit counseling is a good idea for anyone who has problems budgeting. Nonprofit credit counselors provide free advice on creating an affordable budget. For many people, that will be all they need to better manage money and improve their creditworthiness.

For those with deeper debt problems, counseling might not be enough. If their debts have become difficult to pay, a credit counselor might recommend a debt management plan, which is an agency-managed program to consolidate payments and pay off debt.

For some lenders, entering a debt management plan can be a financial red flag, but as you pay off debt, your credit score will likely improve and so will your prospects for landing a home loan you can afford.

Getting a Mortgage with High Credit Card Debt

Lenders want customers who make payments on time. If you have a credit record that suggests you might not do that, your options for getting a mortgage shrink. If your credit history is bad enough, you might not be able to get a mortgage loan at all.

Though lenders consider an assortment of factors including how much money you earn, how much you have saved and how stable your employment is, they focus intensely on your credit score.  The higher your number, the more desirable you are as a loan candidate.

An ideal borrower pays off credit cards balances each month and has a low debt-to-income ratio. If you spend more than you earn, or your debts are more than 40% of what you earn or if you carry balances from month-to-month, you become less desirable. The greater your debt, and the greater the imbalance between what you owe and what you earn, the poorer your borrowing prospects.

The credit-rating bureaus consider five factors when assigning scores:

• Ontime payment history (35%)
• Amount owed (30%)
• Length of credit history (15%)
• Inquiries for new credit (10%)
• Credit mix (10%)

Lenders use your score, income and other financial information to decide how large a loan you can afford.

You will almost always need to post a down payment of 5% to 20% of the home’s purchase price. For lenders, the down payment is collateral – you are less likely to default on a mortgage if you have more financial skin in the game.

Consider Paying off Your Debt before Buying a Home

You will be approved for more money and a lower interest rate by making yourself a more attractive borrower. Your chances at succeeding as a homeowner are significantly improved at lower debt-to-income ratios. Be prudent and pay off your credit card debt before taking homeownership.

If your income grows and you can cut your expenses, you could accelerate your credit card debt payments and be ready to buy real estate sooner. In fact, many people make saving for a down payment their first financial goal after completing a debt management program.

Credit counseling is often the first step toward financial solvency. A nonprofit credit counselor will review your debt and income situation at no cost, and recommend ways to improve your status. In some cases, a willingness to pay down debt and avoid credit cards will allow you to reduce debt on your own.

Many people are too deeply in debt to make that work so they enter a supervised debt management plan. Such plans consolidate payments, reduce interest rates and lower monthly payments. A nonprofit credit counseling agency will collect monthly payments from the debtor to repay creditors. Plans usually involve working with creditors to arrive at an affordable monthly payment that must be agreed upon by both parties. That usually includes the creditor agreeing to reduce interest rates on the debt and waive late or over-the-limit fees.

There are potential downsides to debt management programs. When you close your credit card accounts, which creditors require, your credit score will drop slightly for the first six months or so in the program. However, if you make on-time payments consistently, your score quickly rebounds and, often times, improves.

Also, if you fail to make on-time payments to the agency, the creditor could cancel all concessions (lower interest rate, waived fees) and report the non-payment to the credit bureaus. It then becomes part of your credit history.

Debt management aims at improving credit without turning to bankruptcy court, which can severely damage creditworthiness. A debt management plan is structured to eliminate debt in 3-5 years. As debt is paid down, you credit score will improve and you will become a stronger candidate for a mortgage loan. Once you become accustomed to living within your means, you might become a much better money manager.

Mortgage Provider Alternatives

If you’ve been turned down for a mortgage while in a debt management program and still want to buy, consider other options.

Online mortgage lenders like Quicken and LoanDepot are one alternative. They offer more flexible lending requirements, but their mortgage may be more costly than those available to applicants with sold credit histories.

Mortgage marketplaces like LendingTree, Zillow and E-Loan take your application and present it to a roster of potential lenders, who then provide terms for a loan. You can pursue one or more, and the marketplace site receives a flat fee for the lead.

In some cases, the seller might offer to underwrite a mortgage. This is most common when the seller has trouble finding a qualified buyer for a conventional loan. Since the seller can be the mortgage lender, terms might be less stringent than what a bank would require, and you might be able to negotiate a lower down payment.

Unfortunately, only a small percentage of sellers offer such loans, also called owner financed or purchase-money mortgages. Since sellers usually don’t want to hold a mortgage for decades, they often demand a balloon payment after five years or so, requiring you to find another mortgage to pay off the loan.

There are also lease-to-own options, where you rent a property for a specified initial term with an option to buy it at the end of that period. This can be helpful if you are in a debt management program and expect your credit profile will improve over time. After two or three years of leasing, you might be in a much better position to buy.