Reign in your spending until you close on your dream home.
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When you’re in one of the various phases of the homebuying process, your actions in other areas could determine if you’re successful or not. For example, other types of purchases may appear to be unrelated, but they could negatively affect your mortgage application. “Lenders will review several factors when evaluating a mortgage application, including your credit score, intended down payment, and debt-to-income (DTI) ratio,” says Ashley Moore, community lending manager at Chase Home Lending. And while an increase in your credit score or down payment will be viewed favorably, an increase in your DTI ratio might stop you from being approved.
Here’s what you need to know.
Credit Card Purchases and Loans
We get it: life happens. And just because you’re buying a house doesn’t mean you don’t have other needs. But it’s best to limit big ticket items during this time frame. “If you make a large purchase using a credit card, it increases your debt-to-income ratio, which puts your mortgage pre-approval at risk,“ warns Candice Williams, a realtor at Coldwell Banker Realty in Houston. She says lenders base their decisions based on a snapshot of your finances the day they approve your home loan. “If anything changes – such as an increase in debt – it could put you in a position in which you no longer qualify for the loan.”
And even if your loan has a zero percent interest rate for several months, the purchase could still be problematic. “The minimum monthly cost toward that credit card debt decreases the amount of monthly debt that can go toward a mortgage,” says broker Mihal Gartenberg of Coldwell Banker Warburg in New York, NY.
You may be wondering how anyone would know if you’ve made a large purchase or not. “Your lender has credit monitoring during the mortgage process to ensure you have not opened new credit,” says Tanya L. Blanchard, founder of Madison Chase Capital Advisors. “Any new debt will have to be verified, and could possibly cause your loan to be denied if it adversely affects your debt-to-income ratio.”
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Debt-to-Income Ratio
The debt-to-income ratio (DTI) divides your monthly debt payment by your gross monthly income. Lenders use this formula to determine if you’re qualified for a mortgage. “If a borrower decides to spend a lot of money, it can throw off the debt-to-income ratio which could result in a borrower not being able to qualify to purchase the property anymore, explains Mike Opyd, president/owner of RE/MAX Next in Chicago. Also, if you’ve accumulated a lot of debt from unnecessary purchases, he says this can affect the amount you qualify for – assuming you can even qualify in the first place. “This can result in not being able to look for houses at a price point that would get you all of the things you need and want in a home,” he says.
Cash Purchases
Paying cash for your purchases doesn’t mean that you’ll fly below the lender’s radar. So, let’s say you decided to furnish the new house using cash instead of a credit card. Admittedly, you’re dodging the additional monthly payment that would have resulted from charging the furniture on your credit card or taking out a loan, but you’re still not out of the woods.
“If you were to pay cash for that same furniture, it might mean that you don’t have enough liquid funds available to meet the bank’s requirements post-closing,” says Sarah Alvarez, vice president of mortgage banking at William Raveis Mortgage.
Examples of Large Purchases
Large purchases could include anything from buying a car to buying furniture for a new home. Whether you’re taking out a personal loan, charging large amounts on your credit card or paying cash, it will raise red flags. “Any major purchases can increase your debt level and/or reduce your cash reserve,” Moore says.
Even leasing a car is problematic. “Car leases are viewed similarly to rent: each month, you make payments, but it does not increase your total equity in the car,” she explains. “Leasing a car will increase your debt level, reduce your cash reserve, and therefore increase your debt-to-income beyond what may be accepted.”
Timeframe
If you want to make a large purchase, does it matter where you are in the homebuying process? As a general rule, it’s best to just avoid large expenditures. “It’s important to be cautious about making any major purchases even after you’ve received a pre-qualification or pre-approval,” advises Moore. She says lenders will continue to evaluate your qualifications until the loan is funded.
Alvarez agrees and says a major purchase could prevent you from getting financed – even if you already have a commitment. “All commitments are subject to no material changes, and the bank will continue to update documents and records up through the closing.”
Incidentally, Alvarez also recommends that you don’t make any major changes in employment – and if you do, it must be disclosed to the lender. “Typically, the day of or before the closing, the bank will reach out to your current employer to verify you are still working there under the same terms.”
Workarounds
There are exceptions to every rule, and we realize that some large purchases may be unavoidable. “A new car might be necessary if buyers are moving out of a city with good public transportation and into the suburbs,” explains Gartenberg. And if you’re planning on renovating the home, she says you may want to put down a sizable deposit with your contractor.
“The good news is that buyers can speak with their agent and banker about any big purchases on the horizon – and if a banker recommends holding off, buyers should hold off.”
Gartenberg says most merchants will hold that new car or furniture aside, and after you close on the home, you can proceed with your purchase. “The same goes for contractors – the right one will hold off on taking a deposit from a new homebuyer, because they know how banks operate.”
She recommends taking care of all big purchases on the day of the home closing. “It won’t yet appear on your credit report, and credit card companies will have an easier time approving your credit limit.