When you apply for a mortgage, the lender will take a close look at your financial situation. In some cases, it might make sense to pay off existing debt before applying for a mortgage, but in other instances, it might be better to focus your attention on the down payment.
What a Lender Will Look at
A lender wants to be confident that you’ll be able to handle any existing debt, plus a mortgage, and that you’ll manage your finances responsibly. Paying bills on time and keeping your credit utilization ratio relatively low can help you maintain a strong credit score.
The lender will also consider your debt-to-income ratio, which is calculated by adding the minimum monthly payments due for all debts, such as credit cards and auto and student loans, and comparing that figure to your monthly gross income. If you plan to apply for a mortgage with a co-borrower, the lender will consider both your gross incomes and your total monthly debt payments.
How Debt Could Affect Your Ability to Get a Mortgage
Lenders set limits on total debt, including a mortgage. If you have a mountain of debt now, there wouldn’t be much room left in your budget to cover a mortgage payment, taxes, homeowners insurance and private mortgage insurance (PMI), if applicable. That means you might not qualify for a large enough mortgage to buy the house you want.
What Should You Do?
Since a lender will look at your monthly minimum debt payments to decide how much to loan you for a mortgage, reducing your monthly payments might help you get a bigger loan. You could do that by paying off some or all of your debt, or by consolidating or transferring credit card balances.
On the other hand, if you put down at least 20 percent of the purchase price, you wouldn’t have to pay for PMI. That could save you hundreds of dollars per month. A large down payment could also help you get a mortgage with a low interest rate.
If you have a substantial amount of money that you can put toward a down payment or paying down debt, take the interest rates on your current debts into account. If your existing obligations have relatively low interest rates, you might be better off putting down as much as you can to avoid a high mortgage interest rate and PMI. If you have high-interest credit cards, you’d likely be better off paying off those debts since a mortgage would have a lower interest rate.
Crunch the Numbers
When deciding whether to pay off existing debt before buying a house, consider your current debt balances, minimum payments and interest rates, as well as your debt-to-income ratio, credit score and the approximate price of a house you want to buy. An online calculator can help you estimate how much of a mortgage you could qualify for with different debt levels and down payment amounts.
This article is intended for informational purposes only and should not be construed as professional advice.