When you apply for a mortgage, the lender will look at your income and debt, as well as the amount of money you can put down. Some lenders accept small down payments, while others require a higher percentage down. Lenders also have guidelines related to debt-to-income ratio, as well as the percentage of gross monthly income that goes toward making minimum credit card and loan payments.
When to Prioritize Debt
A lender will limit the percentage of your total income that can go toward debt payments. If a large percentage of your earnings goes toward paying off credit cards, that will limit the amount of money you have available to put toward a mortgage. If you have high monthly credit card payments, reducing or paying off your balances can free up money and help you qualify for a larger home loan than you could afford with a high debt-to-income ratio.
A mortgage lender will also consider your credit utilization ratio, or the percentage of your available credit that you’re using. A high credit utilization ratio can translate to a low credit score, which can make it difficult to qualify for a home loan.
High-interest credit card debt can strain your budget. Interest goes to the credit card issuer and makes it take longer to pay off debt. Money that goes toward interest is money that can’t be put toward a down payment on a house. If you have high-interest credit card debt, make paying it off a priority.
When to Focus on a Down Payment
If you have low interest rates on your credit cards, or if you can use a balance transfer offer to reduce your rates, it may make sense to concentrate on saving for a down payment. If you can put down 20 percent of the purchase price, you will be able to avoid paying for private mortgage insurance, potentially saving you thousands of dollars per year. Under some circumstances, avoiding PMI may save you more money than you could save by reducing your debt load.
If your credit card, auto or personal loan has a low interest rate, but your minimum monthly payments cause you to have a high debt-to-income ratio, you may be able to work out a modified payment plan with the credit card issuer or lender to lower your monthly payments. That will in turn reduce your debt-to-income ratio and the lower monthly debt payments, making it easier to save up for a down payment.
Everyone’s Situation Is Unique
When it comes to saving for a down payment vs. lowering your debt-to-income ratio, there is no right or wrong answer. It’s important to think about your own financial circumstances and goals, consider a variety of scenarios and crunch the numbers to figure out which path makes sense for you.
