Mortgage Money Myths: Should I Pay Off Debt Before Buying a House?
Can You Live in Your Car?
I joke about this with clients sometimes, but there is a serious mortgage lesson behind it.
I’ll talk with someone who wants their new mortgage payment to be around $1,500 per month, but sitting on their credit report is a $750, $900 or even $1,000 monthly car payment.
I’m not here to tell anyone what they should drive.
But when we’re trying to figure out how to make homeownership affordable, we need to look at where your money is going every month, not just the price of the house.
Sometimes paying off or reducing debt can do far more for your monthly budget and mortgage qualification than putting that same money toward a larger down payment.
The question isn’t simply:
“Should I put more money down?”
It might be:
“Where does my money help me the most?”
And that’s a question worth answering before you start moving thousands of dollars around.
Should I Pay Off Debt or Put More Money Down on the House?
Let’s look at a simple example.
As a rough rule of thumb, every additional $1,000 you put toward your down payment might reduce your monthly principal and interest payment by roughly $4 to $7, depending on the interest rate and loan term.
So, let’s say you have an extra $20,000 available.
Putting that $20,000 toward your down payment might reduce your principal and interest payment by roughly $80 to $140 per month.
That’s certainly helpful.
But what if you also have a $20,000 car loan with a $750 monthly payment?
Using that same $20,000 to eliminate the car payment could potentially remove $750 from your monthly debt obligations.
That’s a dramatically different impact on your monthly cash flow and potentially your mortgage qualification.
Does that mean you should automatically pay off the car?
No.
It means we should run the numbers.
Why Does Paying Off Debt Sometimes Help More Than a Larger Down Payment?
One of the things mortgage lenders evaluate is your debt to income ratio, commonly called DTI.
In simple terms, we’re comparing certain monthly debt obligations with qualifying monthly income.
That means the monthly payment attached to a debt can be extremely important.
Consider someone with:
$900 car payment
$400 student loan payment
$600 in credit card minimum payments
That’s $1,900 per month already committed before we even start talking about the new house.
You might tell me:
“Doug, I’m comfortable with a $2,500 house payment.”
And maybe you are.
But we can’t pretend those other obligations don’t exist.
This doesn’t necessarily mean you can’t buy a home.
It means we should identify which debts are having the greatest impact and determine whether changing any of them makes financial sense.
Credit Cards Can Put a Chokehold on Buying Power
Credit cards are another big one.
Someone might have $15,000 or $20,000 spread across several cards.
It’s easy to focus on the total balance, but from a mortgage qualification standpoint, the required monthly payments matter too.
Maybe it’s:
$150 here.
$225 there.
$300 on another card.
Suddenly, hundreds of dollars of monthly income are already committed before we get to the mortgage.
Reducing revolving balances may also affect credit utilization and potentially the borrower’s credit profile, depending on the individual situation.
So, there can sometimes be more than one potential benefit to paying down revolving debt.
But here’s the important part:
Don’t start randomly paying things off.
Let’s look at the mortgage scenario first.
You might be preparing to spend $10,000 solving a problem that isn’t actually preventing you from qualifying.
What About My Credit Score?
This is another reason I want to evaluate everything before you start moving money.
Mortgage qualification isn’t only about DTI.
Your credit profile can affect your available loan programs, mortgage pricing and potentially mortgage insurance.
Paying down revolving credit card balances can sometimes help credit utilization, but credit scoring is complicated and individual results can vary.
And paying off debt is not the same thing as closing the account.
I generally don’t want someone making major changes to their credit profile immediately before buying a home without first understanding the potential consequences.
Talk to your lender before making the move.
What About My Car Loan?
This one comes up constantly.
Maybe you’re almost finished paying it off.
Maybe the balance is relatively small but the payment is huge.
Maybe you recently refinanced the car.
Maybe you have years remaining.
Different mortgage programs can treat installment debt differently depending on the circumstances.
So, don’t assume:
“I owe $8,000 on the car, so I need to pay off $8,000 before I can buy.”
Maybe you do.
Maybe you don’t.
Let’s look at it first.
And yes, I’ll probably still ask:
Can you live in your car?
What About Student Loans?
Student loan debt does not automatically prevent you from buying a home either.
Different mortgage programs can have different requirements for determining the monthly obligation used for qualification.
That’s why I don’t want someone draining $15,000 from savings to pay down a student loan because they heard somewhere that lenders don’t like student debt.
Let’s determine how the debt affects your particular mortgage scenario first.
Then we can decide whether doing something about it actually helps.
A Bigger Down Payment Still Has Benefits
I don’t want this article to leave you thinking:
“Doug says don’t put money down. Pay off debt instead.”
That’s not what I’m saying.
A larger down payment can potentially affect:
Your loan amount.
Monthly payment.
Loan to value.
Interest rate pricing.
Mortgage insurance.
Loan program eligibility.
Cash required at closing.
Overall risk.
There may be an important LTV threshold where putting another $10,000 or $20,000 down creates a meaningful improvement.
That’s exactly why we compare the scenarios.
Maybe the money belongs on the car.
Maybe it belongs on the house.
Maybe it belongs somewhere else entirely.
Don’t Forget About Mortgage Insurance
This is particularly important when we’re deciding between paying off debt and increasing the down payment.
On a conventional mortgage with less than 20% down, you may have private mortgage insurance, commonly called PMI, depending on the loan structure.
Other loan programs have their own mortgage insurance or funding fee structures.
Putting more money down may reduce certain costs, change the loan structure or potentially eliminate mortgage insurance at an appropriate LTV.
So, the calculation isn’t simply:
$20,000 down saves me $100 per month, but paying off the car saves $750.
We also need to ask what that additional down payment does to the entire mortgage.
That’s my job.
Let’s compare both.
Don’t Empty Your Savings Just to Qualify
This one is important.
Buying the house isn’t the finish line.
It’s the beginning.
The air conditioner doesn’t care that you just spent every dollar you had closing on your house.
Neither does the water heater.
Cars break.
Kids need things.
Life happens.
You may also need money for closing costs, reserves, moving expenses, furniture and everything else that comes with owning a home.
I don’t want someone spending $25,000 paying off debt just so they can qualify for a larger mortgage if it leaves them with $300 in the bank after closing.
Sometimes preserving cash is more important than squeezing another few hundred dollars out of the qualification.
Qualifying for the Payment and Living With the Payment Are Two Different Things
I’ve said this before, and I’ll continue saying it:
I don’t live with you. I shouldn’t spend your money for you.
I don’t know how much you spend going out to dinner.
I don’t know what you spend on Amazon.
I don’t know what your hobbies cost.
And yes, I don’t know if you have a gambling or shopping problem.
A lender can determine how much you may qualify to borrow based on lending guidelines.
That’s not the same thing as telling you how much you should spend every month.
My goal isn’t to make you house poor.
It’s to help you understand the numbers so you can make that decision.
Paying Off the Debt Is Only Half the Battle
Here’s the part we don’t talk about enough.
Suppose we determine that paying off $25,000 in credit card debt significantly improves your mortgage qualification.
Great.
We pay it off.
You buy the house.
Six months later, those cards have $20,000 on them again.
Now what?
You have:
A mortgage.
Credit card debt.
Maybe a car payment.
Property taxes.
Homeowners insurance.
Maintenance.
And everything else life throws at you.
We didn’t really solve the problem.
We temporarily moved it.
Part of preparing for homeownership is not simply getting out of debt.
It’s developing a financial plan that helps you stay out of unnecessary debt moving forward.
That’s far more important than qualifying for the biggest mortgage possible.
What If I Already Own a Home?
Now let’s flip the conversation.
Maybe you already own a home.
You’ve built equity.
But you’re also carrying significant consumer debt.
Credit cards.
Personal loans.
Auto loans.
Maybe some combination of all three.
That leads to another question I hear:
Should I Refinance My Mortgage to Pay Off Debt?
My answer?
Maybe.
I know. That’s not nearly as exciting as a yes or no.
But it’s the responsible answer.
If you have substantial equity in your home and you’re carrying high interest consumer debt, it may be worth evaluating whether your home equity can improve your overall financial picture.
Depending on your situation and available loan programs, that could potentially involve:
A cash out refinance.
A home equity loan.
A HELOC.
Or doing absolutely nothing to your mortgage.
What If I Have a Really Low First Mortgage Rate?
This is where the decision gets especially interesting.
Suppose you have a $300,000 first mortgage at 3%.
You also have $60,000 in high interest credit card debt.
Do we automatically refinance that entire $300,000 mortgage into today’s higher rate environment just to access $60,000?
Not necessarily.
Maybe a home equity loan deserves consideration because it leaves that low rate first mortgage alone.
Maybe a cash out refinance still produces a better overall monthly financial picture.
Maybe neither option makes sense.
That’s why I like to call this a:
Mortgage Review
Bring me the mortgage statement.
Bring me the consumer debts.
Let’s look at the balances, interest rates and monthly payments.
Then we can compare the options.
Do nothing.
Cash out refinance.
Home equity loan.
HELOC.
Pay down the debt another way.
The answer isn’t always:
“Yes, refinance.”
And it isn’t always:
“Never touch that mortgage.”
Sometimes the answer is simply:
Let’s see what makes financial sense.
Consolidating Debt Is Not the Same as Eliminating Debt
This might be the most important part of the refinance conversation.
If we use $60,000 of home equity to pay off $60,000 in credit cards, we haven’t magically erased the debt.
We’ve moved it.
And we’ve potentially moved unsecured consumer debt into debt secured by your home.
That deserves serious consideration.
Even more importantly, what happens if we use your equity to pay off those credit cards and then you charge the cards back up?
Now we’ve potentially reduced your home equity and recreated the consumer debt.
That’s worse.
So, before using home equity for debt consolidation, we should have an honest conversation about why the debt accumulated and whether the household budget has actually changed.
That’s not judgment.
That’s planning.
So, Should I Pay Off Debt Before Buying a House?
Sometimes.
Should you put every available dollar toward the down payment?
Sometimes.
Should you refinance and use your home equity to pay off debt?
Sometimes.
I know.
That’s a lot of “sometimes.”
But mortgages are personal.
A strategy that makes perfect sense for one household could be completely wrong for another.
Before moving $5,000, $10,000, $20,000 or $50,000 around, let’s run the scenarios.
What happens if we pay off the car?
What happens if we pay down the credit cards?
What happens if we increase the down payment?
What happens if we keep the money in savings?
What happens if we restructure existing debt?
Sometimes a relatively small change can make a surprisingly large difference.
And sometimes the best mortgage advice I can give you is:
Don’t change anything yet.
Let’s identify the problem before we spend thousands of dollars trying to solve it.
Before You Pay It Off, Let’s Run the Numbers
If you’re thinking about buying a home, send me the debts you’re carrying, the savings you have available and the price range you’re considering.
If you already own a home and you’re considering using your equity to consolidate debt, let’s do a mortgage review.
We’ll compare the options before you move the money.
Because the goal isn’t simply to qualify for another loan.
It’s to determine what makes financial sense for you.
Mortgage Guidance. Not Mortgage Pressure.
Frequently Asked Questions
Is it better to pay off debt or put more money down on a house?
It depends. Paying off a debt with a large monthly payment can sometimes have a greater impact on your debt to income ratio and monthly cash flow than using the same amount for additional down payment. A larger down payment, however, may reduce the loan amount, affect pricing and potentially reduce mortgage insurance. Run both scenarios before deciding.
Should I pay off my car before applying for a mortgage?
Not automatically. The balance, monthly payment, remaining term, available savings and mortgage program all matter. A large car payment can significantly affect mortgage qualification, but don’t spend thousands paying it off until your lender evaluates whether doing so actually helps.
Should I pay off my credit cards before buying a house?
Paying down credit card balances may reduce monthly obligations and can potentially affect credit utilization. However, you may also need those funds for your down payment, closing costs or reserves. Have your mortgage professional compare the options before moving the money.
Should I close my credit cards before applying for a mortgage?
Paying down an account and closing it are different decisions. Closing credit accounts can affect your credit profile, so avoid making unnecessary changes immediately before applying for a mortgage without first discussing them with your lender.
Can I buy a house if I have student loans?
Yes, having student loan debt does not automatically prevent you from qualifying for a mortgage. How the monthly obligation is calculated can vary by mortgage program and your particular situation.
How does debt affect how much house I can qualify for?
Mortgage lenders evaluate qualifying income along with certain monthly debt obligations when calculating your debt to income ratio. Large monthly car, credit card, student loan and other debt payments can reduce the amount of housing expense you may qualify to carry.
Should I refinance my mortgage to pay off credit cards?
Sometimes consolidating high interest debt through home equity can improve monthly cash flow, but it isn’t automatically the right decision. Compare the existing mortgage, new loan terms, closing costs, monthly savings and long term cost. Remember that consolidating debt moves the debt rather than eliminating it.
Should I use a home equity loan instead of refinancing my first mortgage?
It depends on your existing first mortgage, available equity, current rates, the amount you need and the terms of the available home equity loan. If you have a particularly low first mortgage rate, keeping it in place may be worth evaluating before refinancing the entire balance.
