Home > Mortgages > Why Paying Off Debt Could Actually Hurt Your Homebuying Chances

Comments 0 Comments

How you plan and budget your finances can have a big effect on whether or not you can qualify for a home loan. For sound financial planning purposes, eliminating the expenses in your life that contain the highest interest rates first is generally a good approach. After all, why pay more interest, right? But when you apply for a mortgage, the paradigm shifts from paying off high payment obligations to prioritizing paying off debts that can improve your borrowing power. With that in, here are a few things prospective homebuyers should consider.

  • Banks generally do not give any brownie points for you electing to eliminate high-interest debt, but they will score you favorably by paying off debts with big payments.
  • Banks generally are not interested in the terms of your consumer debt obligations.
  • Banks are generally covering themselves first as they are bearing all the risk.

Banks and mortgage companies do factor in what you are obligated to pay each month as a benchmark for determining your credit capacity. This approach might not sound very logical to someone who has a large payment on a credit obligation with a great low interest rate.

Income Remains Supreme

A mortgage is a loan primarily against your income. The simple concept of income to offset a debt payment is what lenders look for among other things like credit, character, collateral and capacity, but income remains supreme. Gross monthly income less payments on current obligations (not what you choose to pay, but just the minimum amount owed) is how lenders will generally determine how much borrowing ability you have. (Credit scores will factor into how much interest you pay on your mortgage. You can check your credit scores for free on Credit.com to see where you stand.)

Consider a car payment at $400 per month (0% interest rate) for a remaining balance of $10,000 versus a credit card payment at $200 per month (16.99% APR) for a remaining balance of $5,000.

If you had an extra $5,000 to pay with, paying down the car would make more financial sense for buying a home than paying off the credit card, even with a 0% APR. Your payment-to-income ratio drives how much house you can really buy. Lenders compute your payment-to-income ratio in the following way:

Sum of your total current payments + proposed total housing payment ÷ monthly income = debt ratio.

Generally, with the exception of Federal Housing Administration Loans, this ratio figure cannot be more than 45% of your total income. In our car example above, paying off the car loan would free up $400 per month in borrowing ability for a mortgage. This translates to about  $40,000 in home-buying power, quite a large number indeed, especially if you’re in a competitive market.

You can follow these steps when you’re getting pre-approved:

  1. First and foremost, pick a reputable, experienced lender.
  2. Identify which debts have the least balances containing the highest monthly payments.
  3. Ask your lender to run scenarios including what you qualify for now with the obligations as is and what you could qualify for if those liabilities were paid off. It’s important to make sure those monies do not hurt the down payment or closing cost figures.
  4. Congratulate yourself on a job well done. Your prudent budgeting may have just opened a door to a new neighborhood.

Every Situation is Different

Each and every homebuying situation is uniquely different. This information may or may not pertain to your specific situation. The whole concept is to cherry pick the obligations that pose the biggest threat to your homebuying ability and pay them off in full if possible. By paying off high debt-payment credit accounts, you also demonstrate you can actually afford the home and subsequent payment you are applying for.

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.

More on Mortgages & Homebuying:

Image: gmast3r

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Credit.com receives compensation for the financial products and services advertised on this site if our users apply for and sign up for any of them.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team