For many people, their mortgage is the biggest debt they incur. Because a mortgage is such an important loan – and it’s paid off over such a long period of time – it’s important that you qualify for the best mortgage rates you can get.
To get a lower interest rate on your mortgage, you’ll want to do everything you can to be the ideal borrower. It means having a great credit score. It’s also a good idea to otherwise excel in the other parameters that lenders look at when deciding whether to grant you financing and at what rate.
When looking for ways to become a more qualified borrower, you might wonder if it makes sense to pay off an outstanding personal loan before applying for a mortgage. Unfortunately, there isn’t one right answer to this question, but here are some things to consider to help you make a decision.
One Email a Day Could Save You Thousands
Expert tips and tricks delivered straight to your inbox that could help save you thousands of dollars. Register now for free access to our Personal Finance Boot Camp.
By submitting your email address, you consent to our sending you money advice as well as products and services which we believe may be of interest to you. You can unsubscribe anytime. Please read our Confidentiality declaration and terms and conditions.
Reasons to repay a personal loan before applying for a home loan
There are a few big reasons why it makes perfect sense to pay off a personal loan before applying for a mortgage:
Paying off the personal loan can improve your debt ratio.
Your debt to income ratio is the amount of your debt to income. If your total debt payments, including your mortgage and other loan costs, are $ 1,200 per month and you have a monthly income of $ 4,000, your debt-to-income ratio (DTI) is $ 1,200 / $ 4,000 or 30%.
Most mortgage lenders won’t give you a loan if your debt-to-income ratio exceeds 43% at most. Many lenders require an even lower debt-to-income ratio to qualify, but while not required, a lower DTI is viewed more favorably and can help you qualify for a mortgage at a better rate.
You will have one less debt payment once you become a homeowner.
Becoming a homeowner comes with a whole host of new expenses, from buying furniture to paying for someone to mow your lawn (or for the equipment and gasoline to mow it yourself). You’ll also have property taxes, utility bills, home repair fees, and HOA fees, depending on where you live.
When you have all of these expenses, you don’t want to owe a lot of money to creditors on top of paying your regular monthly bills. Paying off your personal loan will free up money that you can use for an emergency or home repair fund or that you can use to cover other costs related to homeownership.
Reasons not to repay a personal loan before applying for a home loan
Of course, there are also reasons why you might not want to pay off a personal loan until when you apply for a mortgage. It is important to carefully consider these questions, as paying off a personal loan could potentially Stronger to get a good deal on a house under certain circumstances.
Paying off a personal loan won’t necessarily improve your credit.
Paying off credit card debt lowers your credit utilization rate, or the amount of credit used versus available credit. This improves your credit score.
But prepaying personal loans doesn’t necessarily improve your score. If you pay off your personal loan on time each month, having a mix of different credits on your credit report can actually help boost your score.
You could use up your down payment or your cash reserves.
It is a good idea to put at least 20% on a house. While many lenders allow you to save less, you will likely have to pay for private mortgage insurance (PMI) if your down payment is less than 20% of the home’s value. The PMI can cost around 0.5% to 1% of your loan value each year, so it can be quite expensive.
A higher down payment can also help you get a mortgage at a better rate and can reduce your chances of owing more than the home’s value, which causes a whole host of problems, including making it very difficult to sell. of your house.
If you use a lot of money to prepay your personal loan, you’ll use up the money you have for a down payment and you may end up having to put down less. This makes getting a mortgage more difficult and often more expensive.
Some mortgage lenders also require you to meet certain cash reserve requirements, such as having a few months of mortgage payments in the bank. Spending your money on a personal loan might make it harder to meet this requirement.
Plus, of course, if you’ve spent your money on the personal loan, you have less money for an emergency fund or other costs you might incur as a homeowner.
Personal loans generally have a relatively low interest rate.
The rate for a personal loan is generally lower than that of other types of consumer debt, such as credit card debt, although mortgage interest rates are generally lower than for personal loans.
It doesn’t make sense to pay off a personal loan if you have other debt at higher rates, such as credit card debt. And it doesn’t make sense to pay off the personal loan if it might require you to borrow more from your credit cards after your house is closed to cover moving costs, home repairs, or other expenses.
You could delay buying your home.
If you decide to wait to pay off a personal loan, you could delay buying your home while you work to find the money to pay off your loan. While you wait, mortgage interest rates could go up, making your mortgage more expensive. You are also forced to pay rent for longer and delay when you can start building equity in your home.
Which is the right choice for you?
Ultimately, you will need to take into account the specifics of your own situation. While paying off your personal loan can keep you from making a 20% down payment, make you more likely to take on more debt later, or delay buying a home, it’s often not worth it.
But, if your personal loan payments make your debt ratio too high or there is a risk that you cannot afford both your personal loans and the costs of homeownership, you should wait and pay off. the loan before buying a house.