Does debt consolidation affect buying a home?

If you’ve been dreaming of a home of your own, debt consolidation could be the way to get there. With the right timing, debt consolidation could help you feel more confident and prepared when it’s time to apply for a mortgage. 

Let’s explore how debt consolidation could support your goals and how it impacts your ability to buy a house.

Does debt consolidation affect buying a home?

Yes, debt consolidation could impact your ability to buy a home. Whether it helps or hurts you often depends on when and how you consolidate.

Consolidation could help improve your credit scores over time. It could also improve your debt-to-income ratio (DTI) if you reduce your monthly debt payment.

However, consolidation may initially hurt your credit score due to the new account and change in the type of debt. Closing old accounts after consolidation could also negatively impact your credit scores.

Can you get a mortgage with debt consolidation?

Yes, it's possible to get a mortgage after you consolidate debt. It’s recommended to wait at least six months after consolidation before you apply for a mortgage. Consolidation may initially decrease your credit score, but could improve it over time with on-time payments and reduced debt.

How debt consolidation could help you buy a home

Debt consolidation could be helpful in a few ways, depending on your situation.

Reduce your debt-to-income ratio (DTI)

Your debt-to-income ratio, or DTI, measures how much of your income goes to your debts each month. It's determined by dividing your monthly debt payments by your pre-tax monthly income. 

For example, if you pay $1,000 toward your debts every month and have a gross income of $5,000 a month, your DTI is: 

$1,000 / $5,000 = 0.2 = 20%

Most lenders prefer a DTI of 36% of or less, though a DTI under 50% could still qualify you for some mortgages. 

If you can consolidate your debt while reducing your interest rate, your monthly debt payments could go down. A lower monthly debt amount could improve your DTI and help you get approved for a mortgage or get better terms on your loan.

Help improve your credit score over time

While consolidation can initially ding your credit scores, it could actually help boost them over time. This can be particularly true if you use consolidation to pay off a lot of credit card debt.

Your credit utilization—how much of your credit limits you use—is a big part of your credit score. Paying off credit card debt with a consolidation loan could reduce your revolving credit utilization, provided you don't take on new credit card debt.

On-time payments for your new loan each month could boost your positive payment history. Also, adding an installment loan to your credit mix may have a positive impact on your credit scores.

Free up money

A reduced interest rate could help lower your monthly payments, which may free up some money in the budget. That money could go into extra debt payments. Anything you pay over the minimum goes toward the principal, helping you get rid of debt faster.

Alternatively, a lower monthly debt payment could mean extra money you can put toward a down payment or closing costs. That could help you knock down two significant home-buying barriers.

How debt consolidation could hurt your chances

Debt consolidation could be more of a liability if you don't time it properly. It's best to wait at least six months after debt consolidation to apply for a mortgage loan. That's because consolidation may initially hurt your credit.

A new account could ding your credit score

Any new credit application, such as for a consolidation loan, is going to come with a hard credit inquiry. One hard inquiry doesn't do much damage, but multiple inquiries in a six-month period could have a larger impact.

Once you open the loan, the new account will likely mean your average account age drops. This may also cause your score to drop a few points.

Additionally, consolidation basically moves debt from one place to another. It could take a month or two for that move to reflect on your credit reports. In the meantime, your apparent utilization may increase, temporarily hurting your credit score.

It could lead to taking on more debt

Consolidation is most effective when you don't take on any other debt. This allows you to focus on paying down your existing debt, which is vital when considering buying a new home.

Once you pay off your credit cards with a consolidation loan, be careful how you use them going forward. New credit card debt on top of your consolidated debt could make it harder to get a good mortgage.

How long after debt consolidation can I buy a house?

Generally, you should wait at least six months after consolidating debt to buy a house. This gives your credit reports time to stabilize after the changes. 

That said, you'll likely have the best results if you can wait a year or two after consolidation to buy a home. The extra time could let you pay down your debt balances, improve your credit scores, and build up a down payment.

It also gives the hard inquiry from the loan application, as well as the new account itself, some time to age. Make all the consolidation loan payments on-time every month to show a positive payment history on the new account.

How debt consolidation affects your mortgage terms

Debt consolidation could help you get better terms on a mortgage if done at the right time. Here are two ways it could help:

• Improve your credit score over time. Your interest rate is largely based on your credit profile, so improving your credit score could get you lower rates. Note that consolidation could have a short-term negative impact at first, so it's best to do it at least six months before you apply for a mortgage.

• Reduce your DTI. Consolidating at a lower interest rate could reduce your monthly debt payments and lower your debt-to-income ratio. A lower DTI could help you qualify for a larger loan or better terms.

Best timing for debt consolidation before a home purchase

It's a best practice to wait at least six months after consolidation to apply for a mortgage. It's even better if you can wait one or two years after consolidation. 

Debt consolidation could have a short-term negative impact on your credit. This is due to opening a new account and some changes in debt utilization. Giving it some time after consolidating before applying for a mortgage could help offset the short-term impacts.

You might think of this waiting period as an investment in your future. Each on-time loan payment could bring you closer to the keys to your new home.

What’s next?

Now that you know what to expect, it's time to plan.

• Look over your debts and accounts to figure out where you stand.

• Create a timeline for debt consolidation and buying a home.

• Compare your options for debt consolidation.

• Get started! The sooner you tackle your debt, the closer you could be to shopping for a new home.

Not sure where to start? Achieve can help you explore your debt consolidation options.