If you’re eager to become a homeowner, but you have a significant amount of credit card debt, an auto loan or a student loan, you might be better off waiting to buy a house. Reducing your debt load can help you qualify for a mortgage with a favorable interest rate and save you a bundle. Even a small difference in your interest rate can save you tens of thousands of dollars over the term of the loan.
Reducing Debt Can Improve Your Debt-to-Income Ratio
When you apply for a mortgage, a lender will consider your entire financial picture. Your debt-to-income ratio will be one of the most important factors that will determine whether you’ll get approved for a mortgage and what interest rate you’ll be offered.
Your debt-to-income ratio is the total you pay toward debt every month, divided by your gross monthly income, then converted to a percentage. When you apply for a home loan, a lender will factor in a potential mortgage payment to figure out what your DTI ratio would be. Lenders typically look for a DTI ratio of 43% or less, although each company can set its own guidelines.
If your current debt payments, plus a mortgage payment, put your DTI ratio above a lender’s limit, your application can be denied. If your DTI ratio meets a lender’s criteria, you can get approved for a loan, but you might not get the best interest rate available.
Reducing your debt and DTI ratio before you apply for a mortgage can make you less risky from a lender’s perspective. If a lender is confident that you’ll be able to handle a mortgage, it will offer you a loan with a better interest rate.
Paying Down Debt Can Boost Your Credit Score
Reducing your credit card balances will lower your credit utilization ratio, or the percentage of your total available credit that you’re using. A lower credit utilization ratio can boost your credit score and help you qualify for a mortgage with a competitive interest rate.
You Don’t Have to Eliminate All Debt Before Buying a House
It can be difficult to pay off all your loans and credit card balances before purchasing a house, and it’s not necessary. You’ll be able to get a mortgage if you have debt, as long as you meet a lender’s criteria.
Trying to pay off all your debt before buying a house can even backfire. If you delay a home purchase for too long, you might find that property values have risen and you can’t afford the house you would like, or you might struggle to afford a down payment and closing costs. Work on reducing your DTI ratio and improving your credit enough to secure a loan with favorable terms.