It can be a smart move to pay off your existing debts before applying for a mortgage, but only if doing so isn't going to leave you short of cash for other things. Homes don't come cheaply, , so you're going to need access to ready money to cover your costs. Besides, if you owe relatively little, your debt shouldn't cause you too much of a headache when it comes to applying for a home loan.
Debt won't automatically mess up your chances of landing a mortgage and buying a house. Lenders use debt-to-income ratios when assessing home loan applications. So, while reducing the amount of money a credit bureau reports you as owing is within the debt-to-income ratio your lender uses, it could improve your chances of bagging that home loan. Stressing to clear off every last cent of what you owe might not do you any good at all.
If you have a bit of spare cash floating about that you're considering clearing your debts with, remember that you'll probably need a pretty hefty deposit to secure a mortgage with a competitive interest rate. If your debt to income ratio is low, you might be better off conserving your cash reserves to use as a down payment on your new home. Although it's possible to bag a mortgage by putting down as little as 1 percent, as a rule of thumb, the larger your down payment, the lower your payments will be. Reducing the size of a potential down payment by using any savings you have to clear off all the debt on your credit report could mean you'll wind up forking out less money on interest payments.
As well as having to cough up a down payment, you'll also need some cash to cover your closing costs. The closing fees on a $100,000 loan can amount to between $6,125 to $8,850. You could have these added to your mortgage, but then you'd have to pay interest on them. It's also worth remembering that moving into and perhaps decorating your new home could set you back a few dollars more. There'll be little point in paying off all the money a credit bureau reports you as owing only to take on new debt to meet your closing costs.
Wiping out all your debts will be a good idea if you already have enough money to cover your deposit, closing costs and any other expenses associated with buying a home. Doing so will reduce your debt-to-credit ratio, which could boost your credit score and help you get that all-important mortgage. Resist the temptation to close any accounts you clear. This could cut the length of your open credit history, which could drag down your score.
- Realtor.com: Debt Reduction Not Required to Buy
- The Federal Reserve Board: The Mortgage Application Process
- Business Insider: 4 Money Moves To Make Before You Even Think About Buying A Home Read more: http://articles.businessinsider.com/2012-01-10/news/30606485_1_home-buyers-mortgage-rate-credit-card-debt#ixzz28o8JXngM
- Bank of America: Keeping Your Debt Load Manageable
- The Federal Reserve Board: Mortgage Settlement Costs
- Hemera Technologies/AbleStock.com/Getty Images