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If you'd like to buy a home, carrying credit card debt doesn't have to keep you from fulfilling your dream. But paying down the debt will lower your debt-to-income ratio (DTI) and could strengthen your credit score. That, in turn, will help you qualify for a home loan and potentially score you a lower interest rate.
The decision of whether to pay down credit card debt before buying a home depends on many factors, such as how much debt you have, your income and your available savings. There are a few guidelines, however, that can help point you in the right direction. Here's what to know about credit card debt and homeownership.
Why Is Credit Card Debt a Factor When Buying a Home?
Merely having credit card debt likely won't disqualify you from buying a home. But it may negatively affect you in other ways—for example, in the way mortgage lenders view you as a potential borrower. Here's how:
- Credit card debt increases your DTI. One of the most important elements of your mortgage application is your DTI, including your projected monthly mortgage payment. The greater your credit card debt, the greater your DTI, and the higher the likelihood your mortgage application may be denied.
- Credit card debt impacts your credit score. Lenders look closely at your credit score and at the details in your credit report, including at the types of debt you owe and their balances. Paying down credit card debt lowers your amounts owed, which is a major factor in your credit score.
- Credit card debt limits the mortgage payment you can afford. If you're making a substantial credit card payment each month, taking on a mortgage could be a strain. Not only will lenders take this into account when evaluating your application, but your budget could be overburdened.
When Is Paying Off Credit Card Debt a Good Idea?
In most cases, paying off credit card balances—or paying as much as you can to bring their balances down—is the right move. You'll be able to lower your DTI and, hopefully, increase your credit score and qualify for a lower interest rate on your mortgage.
Here's how it works: The amount of credit card debt you carry relative to your credit limit (across all the cards you have, and for each individual card) makes up your credit utilization rate. This is the second most important factor in your FICO® Score☉ . Mortgage lenders are most likely to use the FICO® Score 2, 4 or 5 models to evaluate your application, but a low credit utilization rate is likely to benefit you for all versions of the FICO® Score. Aim to keep yours below 30% at all times; the lower, the better.
Getting rid of credit card debt could also make a big impact on DTI. Find your DTI by adding together all your current monthly debt obligations, including your likely mortgage payment, and dividing it by your monthly pre-tax income. The ideal DTI—which will get you access to the most favorable mortgage terms—is 36% or less. Certain types of mortgages have slightly less strict DTI requirements, but you should still aim to keep yours lower than 43%.
When Is It OK to Leave Your Credit Card Debt Alone?
In some circumstances, it may not be entirely necessary to pay off all your credit card debt before buying a home. Answer these key questions to determine if you fall into this category:
- What is your credit score? Use a free credit score service, like Experian's, to access your current FICO® Score. While it may not be the exact score that lenders will use (Experian provides your FICO® Score 8, for example, rather than FICO® Score 2, 4 or 5), you'll get a general sense for where your score falls. If it's currently good or excellent—think 700 or higher on an 850-point scale—you may not have to prioritize paying down credit cards, at least in order to bolster your credit.
- Do you have flexibility in your budget? Depending on your income and your current debt balance, you may be easily making your credit card payments (and even reducing your balance). If you're able to pay down debt while saving money each month for emergencies, retirement and other goals—such as your down payment—your credit card debt is likely manageable.
- Do you have a plan to pay off your debt? If you aren't planning to eliminate credit card debt right now, identify ways to pay it off within a reasonable time frame. That's because homeownership will mean adding lots of new expenses to your budget: not just the home loan itself, but property taxes, insurance, maintenance and more. You can safely get a mortgage with some credit card debt if you have a concrete plan in place for how to bring your credit card balances to $0 within, say, one or two years.
The Bottom Line
Paying off credit card debt is one way to put yourself in the strongest position possible to take on a mortgage. If your credit and budget are in solid shape and you're hoping to buy a home quickly, you may not have to focus on getting rid of credit card balances. But it's still crucial to understand how a mortgage will impact your ability to afford your expenses and save for the future.
Use a mortgage calculator to find your potential monthly mortgage payment and see how other housing expenses will affect your budget. Credit card debt shouldn't stand in the way of getting your dream home, and it shouldn't be an ongoing obligation weighing down your budget, either.