There’s a lot to consider when deciding between becoming debt-free first or saving for a house. To reach the most appropriate decision for your finances and financial goals, consider these key factors to help you make an informed decision. The interest rate on your debts is a crucial factor to consider. The higher the interest rate, the more expensive the debt. Look through terms of agreements and statements to find interest rates. You can even talk to lenders and creditors to confirm the interest rates and use that information to calculate just how much interest is costing you. While interest rates on debts vary by lender, creditor and debt type, we’ve collected average rates for common debt types based on average to above average credit scores. If you have a substantial amount of high-interest debt, consider paying it down before saving for a house. Any interest – but especially high-interest debt – can significantly extend your debt repayment timeline and eat away at the money you could be saving for a home. That’s because your interest payments aren’t helping you pay down your debt. The money goes directly to the lender or creditor. Buying a house with student loan debt or other lower-interest debt can be a reasonable decision with careful planning. However, high-interest debt will likely limit how much home you can afford.Interest Rates
Your Credit Score
Consider the amount of debt you have compared to the amount of credit you have available – this is your credit utilization ratio. A high credit utilization ratio can negatively impact your credit score.
Your credit utilization makes up a large portion of your credit score. It’s generally recommended to keep your utilization below 30% to avoid damaging your credit score. If your debt is behind your low score, consider paying it down to help boost your credit score.
Most loans have a minimum credit score requirement. If your score doesn’t meet the criteria for a home loan (or a refinance), it may be challenging to secure a loan or a favorable interest rate and loan terms. Because lenders use credit scores to help them evaluate the risk of lending money, a lower credit typically signals that a borrower has had difficulty managing debt repayment in the past.
If you have a low credit score due to your debt, you may want to prioritize paying down your debt before saving for a home.
Your Debt-To-Income Ratio
Your debt-to-income ratio (DTI) is also a factor lenders use to determine mortgage eligibility. It’s the percentage of your gross monthly income you use to pay recurring debts. Your lender must confirm that you can pay your current debts and comfortably afford your monthly mortgage payment. If your DTI is too high, you may struggle to cover the monthly payment.
Most lenders cap the DTI ratio at 50%. You likely won’t qualify for a loan if your DTI is over 50%. It may raise a red flag for lenders, even if it’s just under the maximum. If you have a high DTI or think your bills are hard enough to manage now, consider paying down your debt.
Trends In Housing Prices
Timing may play a big part in deciding whether to pay off debt or save for a home. Before you settle on a purchase timeline, pay attention to what’s going on in the economy, the real estate industry and the local markets you’re interested in. How are housing prices, inflation and interest rates influencing trends, and which housing market predictions are coming true?
If mortgage rates are low, it may be a good time to purchase a home. However, lower rates may trigger a seller’s market, which may cause home prices to soar and competition to get fierce. Home prices can be lower in a buyer’s market, helping you buy a home for less upfront.
If the trends signal that you should purchase soon, you may want to save for a home. It may make more sense to pay off debts if you’re holding off on buying and are worried about the rates a lender may charge. Factors such as your credit score and DTI will influence the mortgage rate and terms a lender offers.
Dig into housing prices to help determine what’s driving trends – and consider connecting with a real estate agent in the area. Crunching numbers and following trends may not sound fun, but buying a home is a significant and typically long-term investment. Your homeownership journey can only benefit from you and your agent making informed decisions from the start.
Whether You Want To Pay PMI
If you get a conventional loan and put down less than 20% of the home’s value, you’ll pay private mortgage insurance (PMI), which gets added to your monthly payment. If you get a Federal Housing Administration (FHA) loan, you’ll pay mortgage insurance no matter how much you put down. If you make at least a 10% down payment, you’ll pay mortgage insurance for 11 years. If you put down less than that, you’ll pay mortgage insurance for the life of the loan.
If your primary concern is saving a large enough down payment to avoid mortgage insurance, that may be enough reason to decide on saving for a home. However, there are ways to remove mortgage insurance after you’ve purchased a home, such as refinancing your mortgage.
Whether You Have An Emergency Fund
Whether you’re paying off debt or saving for a house, most financial experts recommend maintaining an emergency fund. An emergency fund is money you save to access for unexpected expenses. It can help safeguard you from going into more debt as you pay off surprise costs and keep you from dipping into your savings.
Many professionals recommend making an emergency fund your first financial goal if you don’t have one already. Some recommend saving up to $1,000. Other experts recommend saving 3 – 6 months’ worth of necessary expenses, like rent, utilities and food. The “best” option will always be the one that’s appropriate for your finances and circ*mstances.
An emergency fund is a resource you should maintain even after achieving other financial goals. Your expenses won’t end at the closing table. Owning a home means paying for maintenance, repairs and other costs, including your monthly mortgage payment.
