Paying off debt and saving enough money for a down payment on a home are long-term goals that typically require large sums of money. If you get a work bonus, a gift, or an inheritance, that money can help you reach your financial goals faster. If you’re trying to figure out whether to put extra funds toward debt or a house, here are some points to consider.
The Amount of Debt You Have
If you’ve got a large amount of credit card or loan debt, paying it off (or at least paying off a significant chunk of your balance) can be a smart move. Interest rates on credit cards are generally a lot higher than interest rates on savings accounts. The amount of interest that you can avoid paying on your debt can therefore be much more than the interest that you could earn by putting your money in a savings account.
Your Debt-to-Income Ratio
When you buy a house, a lender will consider your debt-to-income ratio, among other factors. Your DTI ratio is the percentage of your monthly income that goes toward making debt payments.
If it’s high, a lender might deny your application for a mortgage or might approve you for a loan but charge you a high interest rate. Lowering your debt-to-income ratio can improve your chances of getting a mortgage with a competitive interest rate, and it can also reduce the total amount of interest that you’ll have to pay on your debt.
Your Credit Score
Paying off debt can have another benefit: it can boost your credit score. That’s one of the most important pieces of information about you that a lender will consider when evaluating your application for a mortgage.
Raising your credit score can make you more likely to get approved for a loan and help you qualify for a lower interest rate. That will translate to more affordable monthly mortgage payments and lower interest costs over the life of the loan.
When You Want to Buy a House
If you want to purchase a home in the near future, you’ve got little or no debt, your credit cards have low interest rates, and your credit score is in good shape, you might be better off putting your extra funds toward a down payment. That can help you achieve your goal of becoming a homeowner faster.
If you put down 20% or more, you’ll be able to avoid paying for private mortgage insurance. That can save you hundreds or possibly thousands of dollars per year.
Figure Out What’s Best for You
Think carefully about the best way to use extra money. Consider your current debts and interest rates, your income, the amount you already have saved for a down payment, and when you want to buy a house. Consult a financial planner to get advice tailored to your specific circumstances and goals.
