Buying a Home? What You Should Know About Paying Down Debt

If you’re thinking about buying a home, especially if you’re a first-time homebuyer, closely review how much debt you already have. Your debt load dramatically affects whether you’ll get approved for a mortgage and for how much.

Let’s answer some of the most common questions we get about how homebuyers should handle their debt.

Should I Pay Off My Debt Before Applying for a Loan?

Not necessarily. You do, however, need to make sure your debt-to-income (DTI) ratio is in line with your mortgage loan’s requirement. Calculate the ratio by adding up your minimum monthly debts and dividing the total by your total gross income.

Example: Your car loan payment, credit card payments, and other debt payments add up to $1,500. Your gross monthly income is $5,000. $1,500/$5,000 = 30%.

If your DTI ratio is over 43%, you will most likely need to pay down debt before you can secure a mortgage loan.

Will My Debt Keep Me From Qualifying for a Loan?

It might. If you have high debt loads, it can affect both your credit score and your DTI ratio. Mortgage loan programs require minimums on both before they’ll approve a loan.

Remember: You don’t have to be completely debt-free to buy house. Your debt load just needs to be manageable.

Should I Use My Savings to Pay Off My Debt?

It depends. If you would need to use the money you saved for a down payment to pay down other debt, you haven’t put yourself in a better position. You’ve just traded one problem for another.

If, however, you have extra savings that you won’t need to tap during your homebuying process, absolutely use this money to pay down your debt.

Is It Better to Pay Off One Type of Debt vs. Another?

Yes. Pay off your revolving debt (e.g., credit cards) first. The credit report scoring model weighs revolving debt heavier than installment loans (e.g., student loan and vehicle payments). If you can get your credit card debt under control, you have a much better chance of getting approved for a mortgage.

What’s More Important, Saving for My Down Payment or Paying Off Debt?

Unfortunately, both are important when you’re buying a home. Here’s what to do:

• Calculate your DTI ratio (mentioned above).
• Find out how much money you’ll need for a down payment.

If your DTI ratio is too high to get approved for a loan, focus on paying down your debt.

If your DTI ratio is low enough to get approved for a loan, focus on saving for a down payment.

Tip: Keep in mind that some loan programs only require a small amount down. Talk to your loan officer about your options, and craft your plan from there.

Don’t automatically assume that your debt or bad credit will prevent you from getting a mortgage loan. Each case is unique, and you may still meet the requirements for some loans. It’s important that you talk to an experienced loan officer to learn about all your options. They can help you figure your DTI ratio and examine your full financial picture to put you on the right path to homeownership.