Everyone dreams of owning a home but for some, it’s not as easy as it sounds mainly because of the debt that’s standing in their way. Even if you decide to deal with the debt and eliminate it, the path you choose will impact your ability to buy a home. For example, most people who can’t afford to pay off their debt, they choose debt settlement which comes with its own consequences.
Debt settlement sure will help you reduce your debt but it’s not even near to a quick fix. In fact, it can saddle you with more financial issues like bills from the IRS and lower credit score. Both these factors can make it harder for you to qualify for a mortgage. It’s not that getting a mortgage after a debt settlement is impossible. It’s very much possible but for a smooth and seamless process you’ll have to use strategy and caution.
Let’s discuss both debt settlement for credit card debt and mortgage in detail to give you a better understanding of the situation.
What Is Debt Settlement?
Debt settlement is a financial strategy debtors often use when they aren’t able to afford to pay off the amount in full. What happens here is that the debtor negotiates with the creditor and pays a lump sum of the total debt and in exchange the creditor forgives the rest of it. In a nutshell, debt settlement just reduces your debt which makes it easier to pay it off.
Just like any other debt relief option, even debt settlement comes with its pros and cons. Where it reduces your debt, it also comes with several downsides. Most importantly, a debt settlement can stay on your credit report for 7 years and it can bring your credit score down significantly. When it comes to mortgage and debt settlement, it is not the settlement that can become a hurdle, in fact, it’s the impact of the settlement on your credit that can make it harder for you to get a home.
Debt Settlement And Your Ability To Get Mortgage
Here’s how debt settlement can impact your mortgage opportunities;
1-Impact On Your Credit Score
There are pros and cons of debt settlement. The downside is that it can bring down your credit score mainly because it indicates that you are facing a financial hardship, your account will be reported as “settled” instead of “paid in full” and on top of that your missed and late payments will also be reported. Now, the problem arises when the mortgage lenders use your credit scores to evaluate the level of risk involved. A low credit score means that you are a high risk borrower and this can make the approval process a lot harder. Even if you do secure a mortgage, you’ll have to pay higher interest rates.
2- Your Debt To Income Ratio
It’s true that debt settlement can improve your DTI ratio by reducing what you owe but lenders can still see how you reduced the debt. A “Settled” account will show that you weren’t able to pay off your debt in full and this could raise red flags.
3-Waiting Period Requirements
If you’ve recently been through a negative credit event like a debt settlement then some lenders will require a mandatory waiting period before approving your loan. For example;
- Conventional loan type: 2 to 4 years with an established credit
- USDA loan: 3 years or more
- FHA loan: 1 to 2 years
- VA loan: 1 to 2 years
Tips To Improve Your Mortgage Chances After A Debt Settlement
Fortunately, it is possible to get a mortgage post settlement but it’s important that you prepare for it first. If you want to add strength to your application then here are a few effective tips that can really come in handy;
1-Rebuild Your Credit
The very first step you have to take after a debt settlement is to start rebuilding your credit because that’s what mortgage lenders consider the most. There are multiple ways to improve your credit score. For example, you should start paying all your bills on time, make sure to keep your credit utilization ratio low and opt for a secured credit card or a credit builder loan. With consistent efforts and responsible financial behavior, you’ll be able to see a difference in your credit score within months.
2-Save Money For A Larger Down Payment
If you have a higher down payment, it’ll help reduce the risk of the lender and it will also serve as a compensation for your poor credit history. It’s best if you save at least 10% to 20% to increase your odds of getting your mortgage approved.
3-Try To Find Out Specialized Lenders
There are multiple lenders out there who specialize working with borrowers with a less than stellar credit. It’s best if you talk to a mortgage broker and find out the best options available.
4-Write Down A Letter Of Explanation
If you went through debt settlement due to loss of job or some medical emergency then you can add a letter of explanation with your mortgage application. Lenders might be open to such cases and favor them more.
5-Get Pre Approved
Getting pre-approved is another great strategy you can use to understand the realistic and practical mortgage options you have and it also gives your sellers an impression that you are serious about the mortgage. Moreover, getting pre-approved will give a chance to your lenders to view and evaluate your situation in detail.
Credit Score You Need To Qualify For Mortgage
Different loan types come with different credit score requirements. For example, for a FHA loan you need a minimum 580 credit score with 3.5% down payment and with 10% down payment, you’d need a 500 credit score. In case of a conventional loan, you should have a credit score higher than 620 and for VA loans, there’s no one minimum figure but mostly lenders look for scores between 580 to 620.
In a nutshell, you should never apply for a mortgage immediately after debt settlement. Debt settlement will bring down your credit score and it can become a huge hurdle for you because mortgage lenders often hesitate with high risk borrowers. It’s best if you wait for 12 to 24 months before applying for a mortgage and ensure that during these months, you do all that you can to improve your credit score. Your “Settled” account will still stay there for 7 years but if you want to improve your chances of getting your mortgage approved then it’s important that you focus more on the credit score. An improved credit score will leave a positive impression on mortgage lenders. It’ll show them how you’ve been trying to show a financially responsible behavior and how you’ve mended your past record.
Final Thoughts
It’s possible to get a mortgage after a debt settlement but it requires patience, effort and most importantly you need financial discipline. You can easily convince your lenders that you are all ready for homeownership by just paying your bills on time, maintaining a stable income and spending less of your credit. Even if one of your lenders rejects your offer, don’t lose hope because every lender is different and a single rejection doesn’t mean that you’ll be out of options.
Even after debt settlement homeownership is an option and you can prove yourself to your lenders with consistent efforts. It’s best if you seek professional help and advice during this phase. Talk to a financial consultant, discover your options and wait till you really are prepared to apply for a mortgage. Especially if you are still in the process of debt settlement then try Mountains Debt Relief to ensure a smooth and seamless settlement that won’t wreak havoc on your credit.
FAQs
Q1. Will Debt Settlement Affect My Mortgage Interest Rate?
Yes, if you have a low credit score due to debt settlement then it may result in higher interest rates. However, you shouldn’t lose hope because you can still make efforts to improve and rebuild your credit. It’s best to wait and apply for a mortgage only when your credit score is in good shape. This way, you’ll be able to secure better interest rates.
Q2. Can I Get A Mortgage With The Help Of A Co-Signer?
Yes, your chances of mortgage approval can increase with a co-signer, especially the one who has a solid credit history and a stable income. However, even with a co-signer, both the credit profiles will be reviewed and your co-signer will be equally responsible for the loan.
Q3. Will Lenders Consider My Application If Only One Loan Has Been Settled?
Yes, settling a single account is still less damaging than settling multiple accounts. Some lenders will approve your application if the rest of your credit profile is strong enough and if you’ve made efforts to rebuild your credit score.