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-- Posted: April 7, 2000

Dorothy Rosen -- The Dollar Diva Ask the Dollar Diva

Should I save cash or pay off debt before I buy a home?

Dear Dollar Diva,
When trying to qualify or pre-qualify for a home loan, is it better to save for a down payment or pay off credit card debt?

You don't say how much credit card debt you have or what size house you are thinking of buying, so let's go through some of the variables.

If your credit card debt is stinking up your credit report, then you may not even qualify for a mortgage. In that case, it would be best to pay down the debt and cancel some of those cards before applying for a mortgage. But since you are already thinking of buying a house, we'll assume your credit card debt isn't so bad.

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Let's say you could save $5,000 in the next year and were deciding between paying down debt or saving up a down payment. When the mortgage banker looks at your finances to qualify you, he'll be looking at your net worth -- assets minus debts. Either way, you'd look the same. If the $5,000 were in a saving account, it would be offset by the debt. If the $5,000 were used to pay down the debt, it would be offset by the lack of savings.

In one way, saving vs. paying off doesn't matter. In another way, it matters. The debt adds interest, becoming a bigger negative. Therefore, I'd pay off the debt first. It's weight around your neck -- get rid of it.

The mortgage banker will also be interested in how you handle your debt. He'll look at your past experience with debt before allowing you to take on more. Timely payments are important, so definitely keep sending in something each month even if you decide to save the down payment. Having debt is less of a problem than not dealing with it responsibly.

If you are thinking of buying the house while you still have debt, consider whether you can handle the mortgage payments and the credit card bills. If taking on a mortgage is going to have you paying a minimum balance on the other debt, then it's not a very good option.

Many financial experts recommend that your mortgage costs be no more than 28 percent of your gross monthly income. And that your total debt payments (including that mortgage) add up to no more than 36 percent of your income. The math isn't too complicated. Just divide your debt by your income.

For example, if the debt is $10,000 and you make $30,000 per year, your debt load is 33 percent of your income. Adding a mortgage on top of that would hurt a bit. If you are straining at the edges of those numbers, consider waiting a while.

I'd pay off the credit card debt. Then save for the down payment. Your down payment may be smaller, but it won't have the shadow of debt over it. Your overall financial picture will be rosier.

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