Will Debt Consolidation Affect My Ability to Buy a Home? (2024)

Taking steps to consolidate debt can make sense in a range of different situations, whether you need to secure a better interest rate or are tired of making several credit card and loan payments each month. But what happens when you need to consolidate debt around the same time you plan on purchasing a home? While debt consolidation has the potential to lower your
debt-to-income (DTI) ratio, which would positively affect your credit score (and therefore your chance of being approved for a mortgage), it may have the opposite effect depending on your new loan's term length and monthly payment.

Key Takeaways

  • Debt consolidation loans typically come in the form of personal installment loans, but it's also possible to consolidate debt with a balance transfer credit card or a home equity loan.
  • The main factor debt consolidation plays a role in when applying for a mortgage is your debt-to-income (DTI) ratio, which is determined by comparing your monthly bill payments to your gross monthly income.
  • The maximum DTI you can have to get approved for a mortgage depends on the type of home loan you apply for.

How Debt Consolidation Can Impact Your Credit Score

Debt consolidation can impact your credit score in a few different ways, but the positives can outweigh the negatives. It all starts with the fact that applying for a new loan prompts a hard inquiry on your credit reports, which can temporarily ding your score. This is because new credit makes up 10% of your FICO scores, and every new account you open is taken into consideration.

From there, you get the chance to improve your credit by making on-time payments on your new debt consolidation loan. This factor is important because, at 35%, your payment history is the biggest determinant of your FICO score.

Beyond that, paying off your existing credit card bills with the new loan will lower your credit utilization ratio overnight. This can also help your score, as how much debt you owe in relation to your credit limits makes up another 30% of your FICO score.

Debt Consolidation and Mortgage Approval

The exact requirements to get approved for a mortgage depend on the type of home loan you hope to have. For a conventional mortgage, the basic requirements to get approved include:

  • Down payment of at least 3% to 5%
  • 620+ credit score
  • DTI ratio of 50% or less

The last basic requirement, your DTI ratio, is the major factor that can be impacted by debt consolidation. This factor is calculated by taking the sum of your monthly debt payments and dividing them by your gross monthly income. So, if your monthly debt payments add up to $2,000 and your gross monthly income is $6,000, your DTI is 33%.

Because consolidating debt at lower interest rates than you have now can lower your monthly payments, this step has the potential to lower your DTI. However, debt consolidation could also increase your DTI if you opt for a debt consolidation loan with a shorter term and a higher monthly payment.

Ultimately, this is why you'll want to consolidate debt with the longest term and lowest monthly payment you can qualify for if you plan to purchase a home. Remember you can always pay more than the required monthly payment on a personal debt consolidation loan, although you should confirm there are no prepayment penalties before you do so.

Refinancing and Debt Consolidation

Similar rules apply if you are planning to refinance a home around the time you're working on debt consolidation. The maximum DTI you can have for a refinance loan depends on the type of mortgage you plan to refinance with. For refinance loans backed by Fannie Mae, for example, the maximum DTI is typically at 36% but can be increased to 45% for borrowers who meet certain requirements.

Once again, this means that securing a debt consolidation loan with the lowest required monthly payment can make it easier to qualify for a home refinance loan. That's because, generally speaking, having a lower amount of bills to pay each month will tell lenders that you have more available income to make mortgage payments.

Considerations Before Consolidating Debt for a Mortgage

There are special considerations to think over if you're hoping to consolidate debt around the same time you purchase a home. Keep the following factors in mind:

  • Check your credit score: Checking your credit score to see where you stand can help you determine whether you can qualify for a debt consolidation loan with the best rates and terms available today.
  • Get pre-qualified: Most companies that offer personal loans for debt consolidation let you "check your rate" and see available monthly payments and loan terms before you apply.
  • Figure out your old vs. new monthly payment: Once you have an idea of what your monthly payment could be with a debt consolidation loan, you can compare that amount to what you're currently paying toward credit card bills and other debts.
  • Determine your DTI: Add up all your monthly debt payments, figure out your monthly gross income, and run the numbers to figure out your DTI. See if your DTI falls within the range to get approved for a home loan after you consolidate.

Types of Debt Consolidation and Mortgage Implications

While one of the most common forms of debt consolidation is a personal installment loan, there are other types of loans that can work for this purpose. Consider how each type of debt consolidation loan might impact your ability to get approved for a mortgage.

Personal Loan

Personal installment loans come with fixed interest rates, fixed monthly payments, and a set repayment term that doesn't change. As we mentioned already, getting a lower monthly payment on a personal debt consolidation loan can lower your DTI and make it easier to qualify for a mortgage. However, the opposite is also true, and a debt consolidation loan with a higher monthly payment could make qualifying more difficult.

Balance Transfer

Balance transfer credit cards offer a 0% annual percentage rate (APR) on balance transfers (and sometimes purchases) for up to 21 months, although balance transfer fees apply. Transferring debt to another credit card that has zero interest should lower your credit utilization ratio right off the bat, as your new payment will be much lower due to the lack of interest. However, you need to keep your old credit card accounts open with a $0 balance to keep your credit utilization ratio as low as possible.

Home Equity Loan

If you currently own a home and have considerable equity, you can consider borrowing money for debt consolidation with a home equity loan that uses your property as collateral. Just remember that some lenders will only let you borrow up to 85% of your home's value across all home loans you have, including the primary mortgage and home equity loan products.

Best Practices for Debt Consolidation and Mortgage Management

Managing the payments on a mortgage, a debt consolidation loan, and any other bills you have to pay can be challenging, but there are steps you can take to make the process easier. The following tips can help you maintain your finances and improve your credit score over time.

  • Start using a written monthly budget: Borrowers need to avoid the overspending that got them into debt in the first place, and a written monthly budget can help. In lieu of writing out all your expenses and bills each month with pen and paper, you can also use a number of different budgeting apps to track your spending and create a plan for the money you earn.
  • Pay all your bills early or on time: Since your payment history is the most important factor that makes up your credit score, making all bill payments on time (or earlier, if feasible) is crucial. You can even consider setting up some of your bills for automatic payments if you're afraid you'll forget.
  • Avoid new debt: Consolidating several debts into a new loan can leave you with credit cards that have a $0 balance. Keeping these accounts open can help keep your credit utilization ratio lower, but you may want to store your cards in a safe so you're not tempted into new spending.

How Does Debt Consolidation Affect Credit Scores?

While taking out a new loan can cause a hard inquiry on your credit report that temporarily dings your scores, debt consolidation can help your credit score thereafter. Not only can making on-time payments on a new loan improve your score, but paying off debt can lower your credit utilization ratio.

What Factors Should I Consider Before Consolidating Debt for a Mortgage?

You'll want to consider not only the financial savings you could get with a debt consolidation loan but also whether your required monthly payments will go up or down. This factor can impact your DTI, which can affect your ability to qualify for a mortgage.

How Do Lenders Evaluate Mortgage Applications With Debt Consolidation?

Lenders look at several factors when considering a mortgage application, including your regular income, your credit score, your down payment amount, and your debt-to-income (DTI) ratio. As long as you meet the minimum mortgage eligibility requirements after you consolidate debt, the fact you have a debt consolidation loan won't make much of a difference.

What Are the Best Practices for Managing Debt Consolidation and Mortgages Simultaneously?

Start using a written monthly budget that plans out your spending in a thoughtful, comprehensive way, then track your actual purchases and bill payments throughout the month to make sure you stay on track. Pay all your bills on time each month, and do your best to avoid racking up new debts.

The Bottom Line

Debt consolidation can lead to significant financial benefits, especially for borrowers who have a lot of high-interest debts to pay down. This is true for people planning to purchase a home just like anyone else, although potential homebuyers will want to make sure they're consolidating debt in a way that doesn't impact the home-purchasing process. For the most part, this means choosing a debt consolidation loan that won't increase their DTI ratio so much that it hurts their ability to get a mortgage.

Will Debt Consolidation Affect My Ability to Buy a Home? (2024)


Will Debt Consolidation Affect My Ability to Buy a Home? ›

5 As we mentioned already, getting a lower monthly payment on a personal debt consolidation loan can lower your DTI and make it easier to qualify for a mortgage. However, the opposite is also true, and a debt consolidation loan with a higher monthly payment could make qualifying more difficult.

Will debt consolidation hurt my chances of getting a mortgage? ›

Generally speaking, having a debt consolidation loan will not have a negative impact on your ability to refinance your home or obtain a new mortgage. In fact, it may actually improve your ability to qualify. One thing that a lender will assess during the mortgage or refinancing review is your debt-to-income ratio.

How long after debt consolidation can you buy a house? ›

However, most experts recommend waiting at least 2 years after finishing debt settlement before applying for a mortgage. Waiting gives you time to: Improve your credit – Negative marks from debt settlement stay on your credit reports for 7 years. But their impact lessens with time.

Will debt settlement stop me from buying a house? ›

If their credit scores are good enough, a home buyer can qualify for a conventional mortgage while still in debt settlement,” says Dan Green, CEO of Homebuyer.com. “There's no designated waiting period like with a bankruptcy or recent short sale.”

What is a disadvantage of debt consolidation? ›

Your debt consolidation loan could come with more interest than you currently pay on your debts. This can happen for several reasons, including your current credit score. If it's on the lower end, lenders see you as a higher risk for default. You'll likely pay more for credit and be able to borrow less.

How many points does a debt consolidation affect credit score? ›

If you do it right, debt consolidation might slightly decrease your score temporarily. The drop will come from a hard inquiry that appears on your credit reports every time you apply for credit. But, according to Experian, the decrease is normally less than 5 points and your score should rebound within a few months.

Can you still get a loan after debt consolidation? ›

It is possible to get a home loan and very possible to get a car loan, student loan or new credit card while you're on a debt management program. Nonetheless, a good nonprofit credit counseling agency would advise you to slow down and weigh the risks before acting.

How long does debt consolidation stay on your record? ›

Debt consolidation itself doesn't show up on your credit reports, but any new loans or credit card accounts you open to consolidate your debt will. Most accounts will show up for 10 years after you close them, and any missed payments will show up for seven years from the date you missed the payment.

Should I clear all debt before applying for a mortgage? ›

Aim for a gap of at least six months to show you can meet your repayments before you apply. You could also boost your appeal by closing old credit or store card accounts you no longer use. It shows you're in charge of your spending, and can reassure lenders you won't suddenly crank up your future spending.

Should you get out of debt before buying a house? ›

If you have a substantial amount of high-interest debt, consider paying it down before saving for a house. Any interest – but especially high-interest debt – can significantly extend your debt repayment timeline and eat away at the money you could be saving for a home.

What is considered a lot of debt when buying a house? ›

Most mortgage lenders want your monthly debts to equal no more than 43% of your gross monthly income.

What debt is considered when buying a home? ›

Back-end ratio

The back-end DTI includes all your monthly debt payments — such as credit cards, student loans, personal loans and car loans — in addition to the mortgage payment. Back-end ratios tend to be higher, since they take into account all of your monthly debt obligations.

Is consolidating debt a good idea? ›

Consolidating debt can be a good idea if you have good credit and can qualify for better terms than what you have now and you can afford the new monthly payments. However, you might think twice about it if your credit needs some work, your debt burden is small or your debt situation is dire.

How much debt is too much to consolidate? ›

Success with a consolidation strategy requires the following: Your monthly debt payments (including your rent or mortgage) don't exceed 50% of your monthly gross income. Your credit is good enough to qualify for a credit card with a 0% interest period or low-interest debt consolidation loan.

How bad does debt consolidation hurt your credit? ›

Debt consolidation can negatively impact your credit score. Any debt consolidation method you use will have the creditor or lender pulling your credit score, leading to a hard inquiry on your credit report. This inquiry will decrease your credit score by a few points. However, this credit score decline is temporary.

Why not to consolidate loans? ›

You are then paying interest on that higher principal. May pay more over the life of the loan: Though consolidation can lower your monthly payment by, for example, extending your repayment term, that means you'll end up paying on your loans longer and ultimately paying more over time in interest.

Will a debt consolidation loan hurt my credit score? ›

Consolidating your debt can lower your monthly payments, but it can also cause a temporary dip in your credit score.

What risk does debt consolidation bring? ›

Debt consolidation might lower your monthly payments, make managing your monthly payments easier, decrease your interest rates and save you money overall. But there are also potential drawbacks, such as upfront fees and the risk of winding up deeper in debt.

Does debt consolidation affect your credit history? ›

The addition of a new account: If you're opening a new account to consolidate your debt, such as a balance transfer credit card or a personal loan, the new account will lower the average age of all of your accounts, which can negatively impact the length of your credit history.


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