Depending on how much debt you have overall, you may not need to pay off your credit card debt before applying for a mortgage. That said, it could be a smart move. High credit card debt can hurt your credit score and negatively affect your debt-to-income (DTI) ratio, which can make it harder to qualify for a mortgage. Or even if you are approved, you may not be able to get the lowest interest rate possible, which can save you thousands over the life of the loan.
If you’re in the market to buy a house, the first thing most people think about is the cost of the home. And while it’s important to come up with a price range, you also need to budget for your monthly mortgage payment. Your mortgage payments vary based on the amount you’re financing and on the interest rate you’re paying.
Your credit score has a lot to do with the mortgage rate you can qualify for, and carrying credit card debt can have a big impact on your credit score. It all depends on how you manage it and how much debt you’re in. Read on to learn more about how credit card debt affects your ability to get favorable mortgage terms and monthly mortgage payments you can live with.
Should you pay off credit card debt before applying for a mortgage?
Not everyone needs to pay off their credit card debt to get a good mortgage rate. For example, if you have a good credit score, a healthy income, savings in the bank, and a strong down payment — and don’t have a giant amount of credit card debt — it may not be necessary to pay off that debt before applying for a mortgage. In that case, you may still qualify for a lower interest rate even while carrying credit card debt.
On the other hand, if you need to boost your credit score and lower your debt-to-income ratio, paying off your credit card debt is a solid way to accomplish both of those objectives. You won’t regret it when you see how much money you can save over the life of the home loan. Plus, a lower interest rate also results in a smaller mortgage payment to fit into your monthly budget.
|Credit score||APR||Monthly payment||Total interest paid|
|760 - 850||6.129%||$304||$59,416|
|700 - 759||6.351%||$311||$62,014|
|680 - 699||6.528%||$317||$64,104|
|660 - 679||6.742%||$324||$66,652|
|640 - 659||7.172%||$338||$71,841|
|620 - 639||7.718%||$357||$78,556|
|*Rates above for a $50,000 30-year fixed rate mortgage.|
Another school of thought that some experts suggest is to begin the pre-approval process before deciding whether you need to clear up your debts.
“There is no one-size-fits-all answer to the question of debt payoff prior to [a] loan application. The amount of permissible debt is relative to how much someone wants to get approved for. A rule of thumb is to wait until after you have submitted an application to a loan officer to discuss whether paying down debt makes sense for you,” says John Aguirre, owner of John Aguirre Home Loans.
How mortgage lenders determine loan approval
Lenders of all kinds look at multiple pieces of your financial situation to decide if you’re qualified for a home loan and can successfully manage the mortgage payments. This is a good thing because it means if you’re a little weak in one area, you may be able to make up for it in another.
These are just some of the things your mortgage lender may look at:
- Overall credit score
- Details of your credit history like DTI ratio, payment history, and credit card utilization rate
- Size of down payment
- Work history
- Loan type
Credit card debt is just one piece of the puzzle, but it’s an important part of the approval process. Lenders want to see that you’re not only responsible with your debt (e.g., no late payments) but also that you’re not using too much of your available credit.
How credit card debt impacts mortgage approval
The fact that you owe money and have credit card debt doesn’t automatically mean you won’t qualify for a home mortgage loan. That said, excessive debt can be seen as a red flag to mortgage lenders.
Depending on the particulars of your debt, especially as it’s reflected in your credit report and as it relates to your gross monthly income, you may be perceived as a higher risk.
Credit utilization ratio
Your utilization ratio, or credit card utilization ratio (CCU), is the number that explains how much credit you’re using in relation to your credit limit. Say you have $10,000 in available credit and your credit card balances equal $1,000. That means your CCU is only 10%, which is excellent.
Your CCU accounts for roughly 30% of your credit rating (second only to payment history), so it has a big impact on your overall credit scores. It also speaks to your ability to afford another monthly payment in your budget for a mortgage loan.
“If you have a low credit utilization ratio, meaning you’re not using much of your available credit, you may not need to pay off your credit card debt before applying for a mortgage,” says Lyle Solomon, principal attorney at Oak View Law Group, a debt expert and advisor with 30 years of experience. “This is because a low credit utilization ratio can indicate to lenders that you’re responsible with credit, which can positively impact your credit score and mortgage application.”
On the other hand, let’s assume instead that you have $20,000 in available credit and your credit card balance is $12,000. That’s a 60% CCU, which won’t look good to lenders.
“If you have a large amount of credit card debt, it may take some time to pay it off. If you plan to apply for a mortgage shortly, it may be best to focus on paying off as much debt as possible before applying,” Soloman advises.
Even more important than your credit card debt in relation to your credit limit is your total debt in relation to your income. In general, if less than 30% of your gross income is spent on debt payments, you’re in pretty good shape as far as lenders are concerned.
Anything much more than 40% to 45% and lenders may consider you a riskier prospect for a conventional loan. Ideally, your debt-to-income (DTI) ratio with a mortgage should be around 36%, although some mortgage lenders will approve your loan at a higher DTI — just expect to pay higher rates. For instance, an FHA loan may allow up to a 50% DTI ratio.
“The type of debt is irrelevant. The dollar amount of the liability each month is what determines the success of the application,” explains Aguirre.
How to calculate debt-to-income ratio
To calculate your debt-to-income ratio, take your total monthly debt payments and divide this by your gross monthly income.
For example, let’s say your total debt payments come to $2,000 a month — including any auto loans, student loans, and personal loans, plus credit card payments. If your gross monthly income is $5,000 month, your DTI ratio would be 40%.
Tips for reducing credit card debt
If you’re not in a hurry to buy a new home, there are a number of ways to reduce your credit card debt sensibly and improve your chances of loan approval.
Snowball or avalanche strategy
Any good debt repayment plan involves making a budget and sticking to it. One way to do this is to use the snowball method whereby you focus on paying off your smallest credit card balance first, only making the minimum monthly payment on your other credit cards. Even paying off a small credit card balance will improve your credit score.
Other financial experts recommend the avalanche method where you concentrate first on the debt with the highest interest rate and go from there. This strategy will save you the most money in the long run but, depending on the size of your credit card debt, may take a little longer to pay off. However, even reducing your balances is beneficial to your credit score.
Especially if you have more than one credit card, consolidating your debts through a personal loan can be a smart way to pay off your credit card balances faster and at a better rate. Keep in mind there will be a temporary dip in your credit scores from a hard inquiry on your credit report.
To get a better idea of what personal loan is best for you, take a look at some of the options below.
Transfer balance to a 0% credit card
Any time you carry debt on a credit card, you’re charged interest at rates that can vary between 16% and 20%-plus. But if you can roll over your existing debt into a credit card with a 0% introductory rate (usually good for 6 to 18 months), you can eliminate interest charges so your credit card payments whittle down that monthly debt much faster.
Compare your options for different balance transfer cards with a 0% APR introductory period using our tool below.
What’s included in my monthly mortgage payments?
When figuring out how much you can afford for a mortgage, it’s important to remember that your monthly payment is more than just the amount needed to cover the mortgage payment itself. In most cases, the “mortgage” payment also includes your homeowners insurance and property taxes as well, which add significantly to your total monthly payment.
What if I only qualify for high mortgage rates?
If you’re looking to buy a new home right away but your loan approval comes with high rates, don’t despair. Interest rates fluctuate regularly and there’s a good chance you can refinance your loan down the road at a reduced rate.
- Credit card debt affects your credit score and can make it more difficult to qualify for a mortgage loan or obtain favorable loan terms.
- Your debt-to-income ratio and credit utilization rate are two factors that lenders look at when deciding if you’re a good risk for a home loan.
- To get the best interest rates, potential buyers should prioritize paying off (or paying down) their credit card debt before applying for a mortgage.
- If you have a good credit score, a healthy down payment, and not many other debts, carrying some credit card debt shouldn’t hurt your chances of mortgage approval.
View Article Sources
- Monthly New Residential Sales — United States Census Bureau
- Mortgages — Consumer Financial Protection Bureau
- How to Prepare Your Credit For Buying a New Home: 10 Tips — SuperMoney
- How to Increase Your Mortgage Pre-Approval Amount — SuperMoney
- 7 Credit Card Debt Forgiveness Options — SuperMoney
- How Much Debt Is Too Much? And What Can You Do About It? — SuperMoney
- What Should You Pay off First: Your Mortgage or Your Auto Loan? — SuperMoney
- Is It Good to Pay Off Credit Card Debt with a Personal Loan? — SuperMoney
- Should You Pay Off Debt or Settle It? What’s Better? — SuperMoney
- How to Finance a House — SuperMoney
- First-Time Home Buyer Guide — SuperMoney