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Should you pay down your debt before buying a house?

By Taylor Medine

March 2022

If you have debt, you’re not alone — the average person owes $23,325 in non-mortgage debt, according to a 2021 Northwestern Mutual Report. While prepping your finances for a mortgage, you may wonder if paying off debt balances could help you get approved or get a better interest rate. Here, we explore what role debt plays when applying for a mortgage and ways to tackle debt.

How debt affects your mortgage

When you apply for a home loan, lenders take a look at your finances and credit history to assess the risk of lending to you. If a large portion of your monthly income goes toward paying off debt, a lender may worry that you’ll have trouble keeping up with mortgage payments. 

Lenders determine whether you can afford a mortgage by calculating your debt-to-income (DTI) ratio. There are two types of DTI ratios — back-end DTI and front-end DTI. Here’s a simple breakdown of how each one works:

Housing ratio or front-end DTI 

The housing ratio (also known as front-end DTI) is a percentage that shows how much of your gross monthly income goes to housing costs alone. You can calculate this by taking your proposed mortgage payment (including homeowners insurance, mortgage insurance, taxes and HOA fees), dividing it by your gross monthly income and multiplying by 100. 

Back-end DTI 

Back-end DTI is a percentage that shows how much of your gross monthly income goes to all monthly payment obligations. When lenders refer to “DTI,” this is usually what they mean. You can calculate back-end DTI by adding up your total debt payments for the month, dividing that total by your gross monthly income and multiplying by 100. 

Here are examples of monthly payments to include in your back-end DTI calculation: 

  • Your proposed mortgage payment
  • Your student loan payments
  • Your car loan payments
  • Your child support or alimony payments
  • Your personal loan payments
  • Your credit card payments

Note that payments for utilities, groceries or other living expenses are not included in your DTI, so you can leave them out of this equation.

What is the ideal debt-to-income ratio for a mortgage?

The debt-to-income ratio for mortgage approval can vary. Generally, lenders view a back-end DTI of less than 43% as being less risky than one that is above 43%, and paying off debt could help you get within this window. But like most things related to money and personal finance, requirements for DTI can vary and paying off debt may not be necessary for everyone.

If you have a high credit score, a large down payment and a lot of cash in the bank, a lender may accept a higher DTI. In their eyes, these compensating factors may suggest you’re still creditworthy and financially secure, even though a larger portion of your income goes to debt.

How debt affects your credit

Besides affecting your DTI, debt can impact your credit score. “Amounts owed” is the second most important factor that goes into the calculation of your FICO Score. A big part of this factor is your credit utilization, which measures the percentage of available credit lines you’re using. 

The general rule of thumb is to use no more than 30% of your available credit card limits. If you’re using a higher percentage of your credit card limits, paying off some debt could lower your utilization and improve your score. With a higher score, you might be able to qualify for better interest rates, which can lead to monthly and long-term savings. 

Just keep in mind that credit requirements can also vary, and you don’t necessarily need perfect credit to get a mortgage. A conventional loan generally requires a minimum credit score of 620. For FHA loans, you may be able to qualify with an even lower score. 

What to consider before paying off debt

Now that we’ve covered ways debt may affect your mortgage, the big question is — should you pay down debt before buying? It depends on factors like the home you’re trying to buy, how much debt you have and the current housing market. 

If you put off buying a home to pay down debt, home prices and interest rates could rise, which may end up costing you more money in the long run. Having credit card debt, student loans or car loans doesn't necessarily mean you can’t qualify for a mortgage. Shopping around could help you find a lender that’s willing to work with you sooner than later. 

If you’re thinking about dipping into savings to pay off debt, first consider how using savings might affect your down payment amount and ability to pay closing costs. If you’re already engaged in the homebuying process, discuss your options with your lender. Your loan officer should be able to help you understand how paying down different types of debt may or may not affect your application for a loan.

Also, find out what requirements lenders have for cash reserves. Some lenders want to make sure you’ll maintain a certain amount stashed away in savings (i.e., cash reserves) after purchasing. This cash is meant to be a financial cushion that can help you cover mortgage payments if you lose your job. It could also help you cover surprise housing-related repairs or maintenance costs. 

How to pay down debt and save

Suppose you decide to crush some debt and top up your savings before buying a house. Reworking your budget to accommodate higher debt payments and savings contributions could help you put a dent in your balance and grow your savings over time. Here are some tips that can help:

  1. Come up with a plan: Draft a monthly budget that outlines your income and expenses for each month. This can give you a greater understanding of what you might be able to save and put toward debt ahead of purchasing. 
  2. Automate that plan: Setting up automatic payments for debt and automatic money transfers from checking to savings can make it easier for you to stick to the budget. 
  3. Do monthly checkups: Finally, check in on your plan each month to see how you’re doing. If you get a raise or expenses change, you can make tweaks to what you’re devoting to savings and debt. 

Whether or not you decide to pay down debt before buying a home, it’s important to remember that a mortgage is a long-term financial responsibility that involves monthly payments. Mortgage DTI ratio requirements are tools that help prevent you from borrowing more than you can afford. Instead of thinking of it as a roadblock, consider it a helpful guideline that tells you what home loan and monthly payment might comfortably fit into your budget.

Travion Boyd

This was very helpful.

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Taylor Medine is a personal finance writer who has covered money topics for various media outlets over the past 7 years. Her work has been published on USA Today, Business Insider, MSN, Yahoo! and more. When she’s not writing, you’ll likely find her attempting (and possibly failing at) a new recipe or chasing after her 1-year-old daughter, Elise.
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