Should I pay off my debt before buying a house?

Should you pay off debt or save for your dream house? It's a common dilemma many prospective homeowners face.

On one hand, clearing debt can improve your financial health and creditworthiness, potentially securing better mortgage terms. On the other hand, saving for a down payment while carrying debt might delay your homeownership plans. Whether you are eager to enter the housing market or aiming for debt freedom, there are pros and cons to each approach.

Prioritizing paying off debt before buying a house takes the skill of striking a balance between the two goals.

Pay off debt vs. save for a house

There are a few different situations and factors in which paying off existing debt or saving to buy a house would be the main priority. You don’t need to be completely clear of debt to be in good standing for a mortgage, in fact some debt can be good. If you’re looking to get approved for a mortgage, you should be aware of the good and bad kinds of debt you currently have.

Some of the most common types of debt people carry may affect your ability to get a mortgage.

• Credit cards: Credit card debt is considered bad debt due to high-interest rates. High levels of credit card debt are seen as a trait of being unable to manage your income and expenses.
• Student Loans: Manageable student loan debt is considered good debt because it’s considered an investment in your future career, with more manageable interest rates.
• Auto loans: For auto loans it’s dependent on how new the loan is. Newer loans (less than 6 months) are more alarming in terms of taking a credit score hit. But as long as the car and the loan are in line with your other bills, it can be seen as okay.

Reasons to pay off debt first

• Higher credit score: The more you pay down your credit card balance, and the less debt you have, the higher your credit score may go. This will increase the likelihood of being approved for a mortgage and getting favorable terms.  
• Lower debt-to-income ratio (DTI): Your debt-to-income ratio shows how much debt compares to how much income you bring in. The better the ratio (lower debt to higher income), the more likely you’ll be approved for a mortgage.
• Better loan rates: Having a lower amount of debt will help lower the interest rate you receive, saving you potentially thousands over the duration of the loan.

Downsides to paying off debt first

• Cash available for down payment: If your focus has been on lowering your debt, you may not have put as much money into saving for the downpayment portion. If you need to pay a lower amount for down payment, this could impact the interest rate you may receive.
• Con: Losing out on home equity: If home prices rise faster than your savings, you may end up paying more for the same property or settling for a less desirable one. Moreover, you may lose the tax benefits of homeownership, such as mortgage interest deduction.

Tips for repairing your debt before buying a house

Refinance loans

Refinancing existing loans can help in paying off debt by lowering the interest rate or extending the repayment period, which reduces monthly payments and freeing up cash. Additionally, refinancing can provide the opportunity to switch from variable-rate loans to fixed-rate loans, which helps with stability and predictability in payments.

Overall, refinancing offers a strategic approach to managing debt by improving loan terms in order to make repayments more manageable.

Repair your credit

Working toward a better credit score can reduce mortgage costs. A higher credit score indicates a lower credit risk, which helps borrowers qualify for lower interest rates and better loan terms.

Lenders use credit scores as a key factor in determining the interest rates they will offer a borrower. An improved credit score can lead to substantial savings over the life of your mortgage.

With a better credit score, borrowers may also have access to a wider range of mortgage products and lenders, allowing them to shop for the most favorable terms.

Does debt make it harder to purchase a house?

High levels of credit card debt can raise concerns among lenders, as it indicates potential financial strain and a higher risk of default. Additionally, existing debt obligations can impact your debt-to-income ratio, affecting the eligibility for a mortgage and the loan amount you can qualify for.

Overall, managing debt, maintaining a good credit score and having sufficient savings are crucial factors in determining your ability to afford a home and secure financing.

• Debt-to-income ratio: The debt-to-income ratio is a measure used by lenders to assess a borrower's monthly debt payments relative to their gross monthly income.
• Down payment: A down payment is the initial payment made by the buyer when purchasing a property, typically expressed as a percentage of the total purchase price.
• Credit score: A credit score is a numerical representation of your creditworthiness, based on credit history and financial behavior. This influences the interest rate, loan terms and eligibility for financing.
• Private mortgage insurance: Private mortgage insurance (PMI) is a type of insurance that lenders require from home buyers who make a down payment of less than 20% on a conventional mortgage, protecting the lender in case the borrower defaults on the loan.

The bottom line

Paying off debt can boost your credit score, lower your debt-to-income ratio, and lead to better loan terms, making it easier to get preapproved for a mortgage. However, it may delay saving for a down payment and miss out on potential home equity.

Ready to explore your options? Get started with Rocket Mortgage^®.