Adam McCann, Financial Writer
Debt consolidation can affect buying a home either positively or negatively, depending on the timing. If you decide to consolidate debt right before buying a home or during that process, it will have a negative impact. Debt consolidation can result in a short-term drop in your credit score because of the hard credit inquiry required when applying for a loan or line of credit. Consolidation could also hurt your credit score by temporarily increasing your overall debt load due to a loan origination fee or a credit card balance transfer fee. A lower credit score could in turn cost you thousands of dollars if it causes you to get a higher mortgage APR than you would otherwise.
On the other hand, if you decide to consolidate debt well in advance of buying a home, it could make getting approved for a good mortgage much easier. Combining your debts into one balance with a lower APR should help you pay off what you owe faster. And if you wait until you pay off most of your balance, you’ll be able to increase your history of timely payments and decrease your overall debt load. Both of those factors will improve your chances of getting a home loan with good rates. You may even be able to buy a home sooner than expected because your existing debts get paid off quicker.
So, rather than buying a home immediately after getting a new loan or credit card for the purpose of consolidation, wait at least a few months until your credit score can bounce back. In other words, use debt consolidation to prepare for a mortgage application instead of trying to do both at once. Below, you can learn more about the various factors to consider when trying to schedule debt consolidation around a mortgage application.
How Debt Consolidation Can Affect Buying a Home:
- Hard inquiry: Applying for a debt consolidation loan or balance transfer credit card results in a hard inquiry into your credit history. This will drop your credit score by 5 - 10 points for several months. This will make it harder to get a good mortgage in the meantime.
- Debt load increase: Fees associated with some forms of debt consolidation can actually increase the amount you owe in the beginning by up to 8%. For example, some loans charge origination fees to open the account, and many credit cards charge fees on balance transfers. That’s significant because lenders consider total debt load when evaluating home loan applications.
- Increased credit utilization: If you consolidate your debts onto a new credit card, your credit utilization ratio may go up. That in turn can have a negative impact on your credit score and therefore your home-loan approval chances.
- Long-term score improvement and debt reduction: While debt consolidation can have negative effects in the short-term, it can boost your ability to buy a home if you consolidate months or years before you buy. You’ll reduce your debt load and build up a solid payment history, both of which are essential for improving your score.
The bottom line is that when applying for a home loan, it’s best to have the highest credit score and the lowest amount of pre-existing debt possible. You’ll need a credit score of 620+ (preferably 660+) for a conventional home loan, according to Experian. And Zillow recommends a debt-to-income ratio of 36% or less when buying a house, and no more than 50%.
So, you probably can buy a house right after consolidating debt, but you may not want to. Rather, it’s best to consolidate your debts well in advance so that you can improve your credit and reduce your existing debt load as much as possible before you begin the home-buying process.
If you want to track your credit score from consolidation through the home-buying process and beyond, create a free WalletHub account. You will be able to see how your score changes every day. You’ll also get personalized tips on how to improve.
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