According to Experian, the average credit card debt in the U.S. in 2021 was $5,525. For people applying for a mortgage loan, credit card debt can pose a problem. If your credit score doesn’t qualify you for the lowest possible rate, you’ll owe thousands of extra dollars in interest over the life of the loan.
You can also be denied a mortgage loan if your credit card balances and other debt are too high, or your payment history lowers your credit score beneath the required threshold.
A home is one of the single biggest purchases the average American will make. With the median sale price of a U.S. house at $360,000, the interest rate you receive really matters. The difference between a 4.5 percent and 5.0 percent rate means $90 dollars a month on a $300,000 mortgage.
That $90 isn’t just money to keep in your wallet, either. With a lower interest rate, you can also choose to make extra payments on your principal each month. Those additional payments can help build equity faster.
When you look online, the low rates you see are “teaser rates,” typically only available to people with excellent credit (a score of 780 or above). It’s important to have a realistic sense of what your rate will be based on your current credit score.
Should you pay off all credit card debt before getting a mortgage? In some cases, especially if your current credit score makes it difficult for you to get a mortgage loan, it’s a good idea to pay down credit card debt. But keep in mind that credit card debt isn’t the only factor in getting mortgage approval. There are other variables (such as your income and employment situation) you need to consider if you carry debt and are looking to be approved.
How does credit card debt affect your credit score?
Paying off your credit card debt can raise your credit score since you will be using less of your available credit and lowering your credit utilization, which accounts for about a third of your credit score. Lenders can see that you have more of your income available to make mortgage payments. However, it’s not always necessary to have an excellent score in order to end up with a competitive interest rate.
If you have a good score (at least 670) and qualify for a private mortgage loan (a fair credit score of 580 is enough for an FHA loan), you can usually buy a “point” for an additional 1 percent of the loan value in order to reduce the interest rate from, say, 5 percent to 4 percent. Over the long haul, that could be a good investment.
Another option is to hold your mortgage for a few years, allow equity to build and then refinance to a lower rate. This can be a riskier strategy since mortgage rates could climb, the price of real estate could drop or both.
How does credit card debt affect getting a mortgage?
Having credit card debt in itself isn’t going to stop you from qualifying for a mortgage unless your monthly credit card payments are so high that your debt-to-income ratio is above what lenders allow. Banks and other mortgage lenders obtain your debt-to-income (DTI) ratio by dividing your monthly debt by your gross (pre-tax) income.
There are actually two different DTI ratios a mortgage lender may consider:
- The front-end ratio divides your monthly housing outlay—including the mortgage payment, insurance, tax and any homeowner association payment—by your gross income. You typically need to stay below 28 percent to be approved.
- The back-end ratio takes your total debt payment into consideration, including your credit card payment. You should aim to stay below 36 percent.
Lenders generally consider the back-end DTI ratio more significant, since it provides a better picture of your ability to make your mortgage payment. And if it’s above 36 percent, you’ll have a hard time qualifying for a loan. Sometimes, lenders don’t even consider installment debt that is almost paid off in their DTI calculations.
Tips to alleviate credit card debt
There are a few ways to pay down credit card debt before you apply for a home mortgage loan, but there could be an impact on your credit score in the short term.
Zero percent APR card
If you get a new credit card with an introductory zero percent APR, you’ll see a slight hit to your credit just for having a hard inquiry on your account. This is something to keep in mind if you plan on applying for a mortgage loan within a few months.
Borrow from friends and family
Another way to pay off debt is to get a personal loan from friends or family members. Just remember that lenders calculate DTI based on your monthly payment amounts, not your credit card balance. Paying off part of a credit card loan won’t affect your DTI that much—though it could be just enough to put you below 36 percent.
Rollover your debt into a personal loan
You could also take out a personal loan and consolidate all of your credit card debt into it. This would typically help lower your monthly debt payments, boosting your DTI ratio.
The bottom line
Credit card debt is costly and should be the first thing you target in a debt-reduction strategy. But if you’d like to buy a house right away, it won’t necessarily be an impediment to loan approval provided that your DTI percentage is low enough and you have good to excellent credit.
Finding the best mortgage rates you qualify for is the first step of your journey. Once you own a home, you’ll be able to build equity and net worth, which can lead to even more debt-reduction options.