Debt Reduction - Learn How to Reduce Your Debt

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Recuding your debt is one of the most important things you can do before buying a home. It will give you a more favorable debt-to-income ratio, which will in turn make it easier to get qualified for a mortgage loan.

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The Importance of Debt Reduction

When you apply for a home loan, the lender will review every aspect of your financial background and history. They will look at your income, your credit score and the level of debt you are carrying. Specifically, they are looking at your debt-to-income ratio (DTI), which measures how much of your annual income goes toward paying off your long-term debt. If your DTI is too high, the lender may view you as a lending risk and reject your application.

This is the first reason debt reduction is important to many home buyers. This is a real problem in the United States, because many people in this country carry too much debt. It can be a financial burden in general, and it can also prevent you from getting a mortgage loan and buying a home. So let's talk about the things you can do to reduce your debt.

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How to Do It Yourself

If you understand the general concepts of personal finance, and if your level of debt is not yet out of hand, you may be able to reduce it on your own. Here are some of the debt-reduction steps recommended by most financial experts:

Step 1 - Determine Your Debt Level

Get out a piece of paper and a pen, or open a blank document on your computer. Make a list of all your individual debts, including the balances and monthly amounts you are paying each month. In this step, you want to focus on high-interest items such as credit cards, car payments and personal loans (as opposed to your mortgage, which probably has the lowest interest rate of all). Paying down these high-interest items first is the key to debt reduction success.

Step 2 - Review Your Budget

Before you move on to this next step, make sure you have your debts listed on paper as outlined above. In this step of the debt reduction process, you will review your budget to determine how much you can put toward paying down debts each month. Start by writing down your monthly income after taxes.

Next, subtract your monthly mortgage or rent payment from the monthly income amount. Third, you need to subtract other expenses that you pay each month, such as insurance bills, groceries, utilities, etc. What you are left with (after subtracting monthly expenses from monthly income) is the amount you have to work with in terms of paying down debt. You need this amount to create your debt reduction plan, which is the next step.

Step 3 - Create a Payment Plan

Now that you have a list of your high-interest debts and a list of your monthly expenses, you create a payment plan to reduce those debts. Take the amount you have arrived at (after subtracting your monthly expenses and payments from your monthly income), and put a portion of that toward paying down your debt.

For the first month of your debt reduction plan, I recommend starting small with the amount you use for this purpose. If it seems like a manageable amount, then the next month you can put even more money toward paying your debt. The key here is to stick with it. If you are consistent in your efforts to reduce your debt you will eventually achieve success.

Of course, it helps to reduce your spending at the same time. The last thing you want to do is pile on additional unnecessary debt while also trying to reduce it. That's like taking one step forward and one step back — you'll never get anywhere.