Debt Consolidation and Home Buying: What You Need To Know

Buying a home when you have an outstanding debt consolidation loan can seem like an impossibility. That’s especially if financing the home involves another round of borrowing. 

However, you don’t need to fret. With due diligence, you can find numerous lenders that offer credit facilities to people with debt consolidation loans. 

Read on as we unpack the relationship between debt consolidation and home buying. 

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What Is Debt Consolidation?

One of the frequently asked questions by debtors seeking to finance their homes is – does debt consolidation affect buying a home

The answer to this question is a resounding yes. And the effects can be good or bad, depending on how you approach the scenario. 

But even before delving into the impacts of debt consolidation in financing a home, it’s fair that we begin by understanding this credit concept. Now, debt consolidation is a debt management technique that involves taking out one loan to pay out other smaller existing loans. 

What Are The Benefits And Drawbacks Of Debt Consolidation?

Debt consolidation helps you stay organized by focusing your attention on a single loan instead of multiple debts. This can significantly lower the default risk, positively reflecting your credit score. 

Besides, the new loan usually comes with lower interest rates. That’s especially if it’s spread over a reasonable repayment period. 

On the flip side, you’ll need to build a solid credit score to qualify for debt consolidation loans. That’s because the new loan tends to be considerably higher than the smaller debts you’re trying to settle. 

It’s also worth noting that debt consolidation may not always attract lower interest rates. As already hinted, interest rates depend mainly on the total repayment period. Several other factors could be at play, such as the loan amount and your credit score.

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Can Debt Consolidation Affect Home Buying?

Debt consolidation loans will undoubtedly influence your ability to finance a home. So, the more pertinent question is not whether but how consolidating your debts may affect your capacity to finance a home. The effects can be positive or negative, depending on various dynamics.

The Negative Effects of Debt Consolidation on Home Buying

Taking out a debt consolidation loan may have an immediate and adverse impact on your credit score. That’s because the process entails closing multiple accounts over a short period. 

Admittedly, the core objective of any debtor is to service their loans as fast as possible. And when you take out a debt consolidation loan, you’ll typically pay all or most of your outstanding debts within a short period. However, credit reporting bureaus may misconstrue this as a red flag. 

The overall effect of poor credit scores is that you’ll need to try harder to qualify for a mortgage. And even if you’re lucky to find a willing lender, the interest rates and other loan terms may not be so friendly. 

Fortunately, there’s a smart way out of this. Instead of settling all your outstanding debts within, say, a couple of days, you could spread the repayment period over a month or two. The idea is to avoid closing multiple accounts over a suspiciously shorter period. 

There’s also the option of contacting the credit reporting bureaus on your intention to take out a debt consolidation loan. Informing these agencies in advance could potentially bar them from scoring your creditworthiness if their systems notice you’ve suddenly closed several accounts at once. 

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The Positive Effects of Debt Consolidation on Home Buying

It’s undeniably true that closing several accounts simultaneously may hurt your credit score. However, it’s important to note that every lender will assess your creditworthiness for each loan you apply for, including mortgages. These assessments might establish that you qualify for a mortgage even if your credit score suggests otherwise. 

For instance, one of the critical aspects most lenders assess during a refinancing or mortgage review is your debt-to-income ratio. 

As the name implies, the debt-to-income ratio (DTI) refers to the comparison between your monthly income and your monthly debts. In other words, the percentage or fraction of your gross (pretax) monthly income goes towards paying debts and basic needs, such as rent and mortgage. 

By way of illustration, let’s assume that you earn $3,000 a month and spend half the amount servicing credit card debts and other basic needs. 

Your debt-to-income ratio would be 50%, which is considerably higher than the 35% – 40% that most lenders prefer. In this case, the lender may need to consider other aspects before advancing any credit facilities to you. And that’s where debt consolidation comes in. 

Consolidating your debts significantly reduces your DTI by lowering the amount of your monthly earnings going to debt repayment. The lower the DTI, the higher your chances of securing a mortgage. 

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It’s possible to consolidate your debts into a mortgage. As expected, there are benefits and drawbacks to doing so. 

The most significant advantage of consolidating your debts into a mortgage is that it could reduce your interest rates dramatically. That’s because you’re essentially using your home as collateral. 

However, there’s one challenge in finding a suitable lender. Besides, it beats logic that you’d offer the home you’re trying to build as collateral for your new mortgage. 

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