Should you Pay Off Credit-Card Debt Before Buying a Home?

When buying a house it is best to take time in advance to get your "financial house" in order. Paying off all your credit card debt in the past was encouraged  may not be the best move. Reducing your debt will definitely impact your credit score, your debt-to-income ratio, but more importantly the amount of "liquid cash" you have in the bank. Consider all three aspects carefully before you make a final decision about your credit card balance.

Cash Reserves vs. Credit Card Debt

Have you been building up your savings to cover your down-payment and closing costs? Think hard before you dip into that fund to pay off your debt.

The median price of a home in the United States in 2014 is around $200,000, most likely you will need a minimum of $7,000 for a down payment for an FHA loan that requires 3.5% down; or $10,000 for a 5% down payment, the minimum required for most  other conventional loans. In addition to the down payment, you will need 3% to 5% of the loan amount for closing costs, which comes to another $6,000 to $10,000. Looking at these two items alone you will need between $13,000 and $20,000 in cash to buy a median priced home.

But don't forget, you will also need money for moving expenses and for cash reserves in case of an emergency. Not all lenders will require that you have cash reserves, but a good rule of thumb is to plan on having at least two months of mortgage payments on hand.

Once you have estimated all these costs, reserved these funds and determined that you can cover them you can safely take the additional cash you have available and pay down or pay off your credit card debt .

What is the Debt-to-Income Ratio

In order to qualify for a conventional mortgage, your monthly minimum payments on all debt must be a maximum of 43% of your household monthly gross income. If you are to be the sole loan holder then only your income will be counted. If your partner or spouse will also be listed on the loan then both income, debt (and credit scores) will be calculated. You need to be aware that some lenders require lower debt-to-income ratios, particularly for borrowers with a low credit score or those that have few cash reserves. If your charge card debt is too high and you are "maxed out" you may not be able to qualify for a mortgage. FHA loans do have looser guidelines, so some lenders offering this type of loan may allow a higher debt-to-income ratio but only under special circumstances. For your own comfort level with your budget it’s best to have a lower debt-to-income ratio.

Clean Up Credit Score Issues

Lenders will rely heavily on your consumer credit scores, this is not only for the loan approval but also to determine the interest rate you will pay for a conventional loan. If your credit score is under 700 or 680, you may want to pay off some or all of your debt to improve your score. If your score is 640 or lower, you may be able to qualify for an FHA loan depending on the rest of your credit history or profile.

Plan smart! If you decide to reduce your debt, be careful not to combine  all your debt on one credit card. Doing this can hurt your credit score more than having a low balance on several cards. Even more important, once you pay off an account don’t close it. Closing credit card accounts will reduce your overall credit availability and shorten your credit history, both of which will lower your score.

One of the best ways to plan and make the decisions about your personal financial situation is to consult with an experienced mortgage lender who can best advise you on what you can do to qualify for a loan that’s affordable and fits your money management plans.