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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.
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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DOROTHY ROSEN has a master's degree in finance, with a specialization in accounting,
from the Kellogg Graduate School at Northwestern University in Evanston,
Ill. Rosen has more than 15 years of experience in the financial arena, serving
in Illinois and Florida as a certified public accountant, financial consultant,
expert witness and educator. She is owner of Dorothy Rosen, CPA, a public
accounting firm that serves individuals and small businesses.
