Should I Get Rid of Debt Before Buying a House?

Buying a house is an exciting milestone in life. But it also involves making some big financial decisions. One question that often comes up is whether to pay off debt or save up for a down payment first. There’s no one-size-fits-all answer. The best approach depends on your unique situation. In this article, we’ll walk through the pros and cons of paying off debt vs. saving for a house so you can make the right choice.

How Debt Impacts Homebuying

Let’s start by looking at how existing debts like credit cards, student loans, and auto loans can impact your homebuying plans:

• Credit score – Too much debt, especially high credit card balances, can lower your credit score A higher score increases chances of getting approved for a mortgage and scoring better terms

• Debt-to-income ratio – Lenders calculate your debt-to-income (DTI) ratio using your total monthly debt payments divided by gross monthly income. The lower your DTI, the more home loan you can qualify for.

• Interest rates – High debt leads to higher mortgage interest rates compared to borrowers with lower debts and better credit This costs more over the life of the loan,

• Down payment – The more money tied up in debt payments, the less cash freed up to save for a down payment. A higher down payment leads to better rates.

So in many cases, paying off debt ahead of buying can put you in a better position as a homebuyer. But it also depends on your goals and timeframes.

Reasons to Prioritize Paying Off Debt First

Here are some reasons why focusing on debt repayment before buying a house could make sense:

• Improve credit score – As noted above, lowering credit card balances and overall debt helps boost your credit score. Excellent credit (740+) means better mortgage terms.

• Lower DTI – Paying off installment loans like auto loans reduces your monthly debt obligations. This lowers your DTI so you qualify for a bigger mortgage.

• Increase savings – The less you owe each month, the more cash you free up to save for a down payment. This helps you buy sooner.

• Lower interest rate – Good credit and low debt gets you the lowest mortgage rates, saving substantially over the loan term.

• Reduce risk – Entering homeownership with minimal debts lowers the risk of mortgage default if you face financial hardship.

Caveat – The only risk with prioritizing debt repayment is that home prices could outpace your savings. Then you may need a larger down payment later.

Reasons to Prioritize Saving for a House

In some situations, it may make more sense to focus on saving up to buy a home first while still paying minimums on lower-interest debts:

• Take advantage of low rates – Current mortgage rates are near historic lows. Paying off debts before buying could mean missing out on these ideal rates.

• Build home equity – Money put towards savings/down payment goes directly towards an asset that builds equity. Paying off a depreciating car doesn’t build long-term wealth.

• Benefit from appreciation – Saving while home values rise can minimize the down payment needed later. If you delay, you may end up having to save more.

• Start building wealth – Owning a home allows you to start benefiting from forced savings, equity, potential appreciation, and tax deductions sooner.

• Low-interest debt is OK – Having some low-interest installment loans like student debt isn’t necessarily an obstacle to homeownership.

The risks with this approach are getting approved for a mortgage with high existing debts and having to accept a higher interest rate.

Tips for Balancing Debt Repayment With Home Savings

For many buyers, the optimal path is to work on paying off debt while simultaneously saving for a home. This balanced approach helps make progress on both fronts. Here are some tips:

• List out all debts by interest rate – focus on paying down high-rate debts first.

• Try to refinance high-interest loans to lower rates. This reduces minimum payments.

• Channel windfalls like tax refunds equally towards debt repayment and home savings.

• Set a budget that allocates something to both goals each month. Even small amounts add up.

• Cut discretionary costs to free up more funds towards both debt and savings.

• Take advantage of employer retirement plan contributions to turbocharge savings.

• Consider balance transfer credit cards to consolidate debts at lower promotional rates.

The right approach depends on your specific debts, timeframes, savings, income, and more. But with strategic planning, you can make steady progress on debt repayment while still saving to buy a home.

Key Takeaways: Should I Pay Off Debt or Save for a House?

• Paying off high-interest debts before buying can improve your credit, lower your DTI, and help you qualify for better mortgage rates.

• But focusing just on debt can mean missing out on low rates or home price appreciation.

• Finding the right balance of debt repayment and saving maximizes your chances of buying sooner and on better terms.

• Refinancing, budgeting, and channeling windfalls to both goals helps make progress on both fronts simultaneously.

• Make a detailed assessment of your debts, assets, timeframes, goals and risk appetite to decide the right path for you.

With some analysis and financial planning, you can determine the smart way to handle existing debts on the journey to buying your first home.