Paying off debt before you buy a mortgage makes good sense — but saving cash for the down payment makes good sense too. There's no universal rule for which alternative is better. To decide, you'll have to look at how much cash you need, and the size of your debt burden.
Paying Down Debt
The standard in mortgage lending is that the monthly PITI payment — mortgage principal and interest, taxes and insurance — should be 28 percent of your income or less. Total monthly debt payment should be 36 percent of your income. If your debt load is higher, you may be unable to get a loan at a decent rate. Paying down your debt to the acceptable level will put you in a much better position to land a low-interest loan.
Most lenders require a minimum 20 percent down payment, though you can get by with less if you take out mortgage insurance. On top of that, closing costs often run 3 to 6 percent of the loan amount, so you'll need several thousand dollars at closing on top of the down payment. If you spend your cash paying down your debts, you may not have enough to close. It's also a good idea to have a cash reserve to cover at least three months of PITI in case of emergencies.
Pros and Cons
Paying off credit cards and student loans before you buy boosts your credit score, which makes you more attractive to mortgage lenders. Many bills, such as credit cards, hit you with substantially higher interest than you pay on your mortgage, and unlike mortgage interest, it isn't tax-deductible. On the other hand, if paying down your debt only frees up $75 to $100 of your monthly income, it's not going to affect your debt-to-income ratio enough to matter.
If you have more than enough cash to cover the down payment and closing costs, paying down debt with the extra is a smart move. If you can't do both, you'll have to apply the general rules to your specific case. If your debt-to-income ratio is dangerously high or your credit score low, paying down debt should be a priority. If the ratio is only 20 percent, you might be better off saving for the down payment. Another option is to look for a less expensive house, so you don't need as much cash for the down payment.