Pay Off Debt to Get a Mortgage

Transcript

Today, we’re talking about how paying off debt can help you get more debt—oddly enough.

My name is Evan Kaufman, your VA loan originator. One way to get a larger mortgage or to be approved for a larger balance is to actually pay off some of your current debts. In this video, we’re going to talk about why that is, and at the end, I’ll go over a real example of how impactful it can actually be.

Why Paying Off Debt Can Help You Get More Debt

So, why is it that if I pay off some debts, I can suddenly be approved for more debts? It comes back to your debt-to-income ratio (DTI). As lenders, this is one of the primary indicators we use to determine whether you qualify for a home loan.

For example, if we’re looking at conventional loans (and most loan types), your debt-to-income ratio typically needs to be 50% or less. For VA loans, the requirements can be more nuanced. Sometimes, they allow a higher ratio, but it’s often based on something called residual income. Still, we need to ensure the DTI makes sense.

What Is the Debt-to-Income Ratio?

In general, the DTI is calculated by taking your total monthly liabilities and dividing that by your total monthly income, which gives us a percentage.

• Monthly liabilities: These include major debts, such as installment loans or revolving credit lines (e.g., student loans, car payments, or credit card balances with minimum payments).
• Things like utilities, rent, and phone bills typically don’t count in this calculation.

When we run your credit, we focus on things like installment loans, car loans, student loans, and other mortgages you might have. These are added up to get your total debt number. We then divide this by your gross (pre-tax) monthly income to calculate your DTI.

A Real-Life Example

Let’s say you’re currently denied for a mortgage because your DTI is too high. You’ve been told to pay off some debts but don’t know why or how impactful it can be. Here’s an example:

You make $5,000 a month in gross income. You have $2,000 a month in car payments and credit card debt, and you’re trying to apply for a mortgage with a $2,000 monthly payment.

• Without the mortgage, your DTI is $2,000 ÷ $5,000 = 40%.
• Add the mortgage, and now your total liabilities are $4,000 a month. Divide that by your income, and your DTI jumps to 80%.

This 80% ratio exceeds most loan requirements, meaning you’ll likely be denied. But here’s the power of paying off debt:

Let’s say you can pay off that $2,000 in credit cards and car loans. Now your only liability is the mortgage, so your DTI goes back down to 40%. With other factors in place, you’re much more likely to be approved.

Another Example

Here’s a more common scenario:

You make $5,000 a month in income and have $1,500 in debt (split between car payments and credit cards). Without a mortgage, your DTI is 30%.

If you take on a mortgage with a $2,000 monthly payment, your DTI increases to 70%. To improve your chances of approval, you decide to pay off some of the debt:

• You can’t pay off your car loan entirely but manage to clear $1,000 in credit card debt.
• This leaves you with $500 in liabilities, plus the $2,000 mortgage.

Your new DTI is $2,500 ÷ $5,000 = 50%, which has a much better chance of approval. While I wouldn’t recommend a 50% DTI long-term (ideally, aim for 35% or less), this shows how debt payments can help you qualify.

By paying off certain debts, you can reduce your DTI and potentially qualify for a larger mortgage. This could allow you to afford a home in the area you want to live in or one that meets your needs better.

For example, if paying off a $300–$500 monthly debt lowers your DTI by 10–15%, that could allow you to qualify for $50,000–$100,000 more in home value.

My name is Evan Kaufman, and that’s how strategically paying off debts can help improve your DTI to qualify for a mortgage and, ultimately, secure a new home.