This is a question I was asked quite frequently during my career as a mortgage loan officer. The easy answer is … it depends. Each of you have a unique financial situation and that means the answer is dependent on several conditions or factors. Here are a few worth considering: Budget, Credit Score, Debt Payoff and Mortgage Insurance. Let’s look at them separately.
What works best in your budget?
You may be surprised to learn just how little your payment is affected by additional down payment on a mortgage. This over anything else, tends to influence consumers to payoff debt before buying house.
Let’s assume you have an extra $5,000 to either pay down a credit card or put toward a down payment on buying a house. You are making interest only payments on the credit card at a rate of 10% and your proposed mortgage would have a rate of 4.00%.
Certainly common sense says to get rid of the higher rate credit card first; but how does that also look on a monthly payment?
- Credit Card: $5,000 at 10% is $500. Divide by 12 for a monthly amount of $41.67.
- Mortgage: $5,000 additional down payment equals $23.87
Yes, the difference is not that substantial, however getting rid of a higher rate credit card debt will be a better financial move for you. Remember; that $41.67 is interest only. It does not reduce the amount you owe.
The other possible benefit to pay down your credit card (or other non-real estate related debt) is the fact that the interest portion of your monthly mortgage payment could have some income tax benefits. The new tax law enacted for 2018 could have an impact on your ability to deduct mortgage interest. I think for the vast majority of us; the impact won’t be an issue. How the New Tax Laws Will Impact Your Housing Costs
What works best for your credit score?
If you have high revolving debt (credit cards); your credit score will be lower. A lower credit score can result in a higher mortgage payment due to increase in the interest rate and/or the mortgage insurance premiums.
There are certain benchmarks when it comes to paying down revolving debt that need to be reached before it would improve your credit score. Some of them are:
- If you are over your limit; absolutely pay that balance down to at least below the limit.
- Paying down your balance below 50% of your limit will help somewhat.
- Getting your balance below 30% can have a substantial impact on improving your score and 10% is even better.
Check out my eBook, 5 Easy Ways To Improve Your Credit Score Now, for more information.
If you don’t payoff debt now; do you have a plan to payoff later?
I’m talking about revolving debt primarily as any installment type of debt (car payments, student loans, etc.) will have a set payoff term. You can always prepay an installment loan; but it is the revolving debt payments that need to be closely monitored. By revolving debt; I am referring to credit cards or any type of debt that has a limit and you can keep borrowing up to that limit.
Credit card debt often has a very low minimum required payment which stretches out the payoff considerably. In May 2009, President Obama signed new credit card rules into law. One of the changes was the credit card company has to show you how long it wold take to pay off your balance if you made the minimum payment AND how much you’d have to pay to payoff your balance in 36 months.
If you decide to put your additional money toward a down payment; be aware of how much you’ll need to pay to get rid of your credit card debt. Factor this into your budget plan in determining what you feel is comfortable for you in a new house payment. (need help with the budget planning – check out my free download, Home Payment Planner)
Here’s a great tip for your to consider. Once you payoff your consumer debt (charge cards, auto loans, etc.); take that monthly payment and apply it each month to the principal of your mortgage. That will benefit you from either having your mortgage paid off earlier OR creating more equity for you to use when it is time to purchase your next home.
What about mortgage insurance?
Mortgage insurance; which is more accurately stated as mortgage default insurance, can play a factor in the down payment question. It is an additional insurance premium you must pay depending on how much money you put down on a home purchase. It is insurance for your lender against a possible default on the mortgage. Statistically lower down payments prove to be a riskier loan for the lender.
Mortgage insurance premiums are dependent on several factors:
- credit score (the lower your score the higher the premium)
- loan program
- down payment amount
It is primarily in conventional loan programs that your down payment amount will affect your mortgage insurance premium. The tier level that affects the premiums is as follows:
- 3% down
- 5% down
- 10% down
- 15% down
- 20% down
Additional down payment may, or may not, affect your insurance premium. For example, if the additional funds you have for down payment will move you from 5% down to 7% down; your premium will not change. If, however, your funds will move you from 5% down to 10% down; your premium will be reduced.
As you may not begin to realize; the answer to the question “should you payoff debt before buying house?” truly is “it depends!”
The best possible decision you can make on this subject is to keep your money in savings until you can have a discussion with your loan officer. An experienced loan officer will take the time to look at your overall qualifications for the loan; but they will also present you with the pros and cons as they fit your current circumstances. Pros and cons not just for getting a mortgage; but how this will affect you for the long term after you have purchased the home.
Please leave any comments or questions on this article below. Your feedback is important to me!