Dear Penny: We Want to Buy a House, but We Have $60K in Debt

A woman displays her credit score on her cell phone using Credit Sesame outside of her house.
Tina Russell/The Penny Hoarder
Dear Penny,

After six years of renting, my husband and I are hoping to buy a house within the next year. But even though we both work full time and have been trying to pay down our debt, we still owe over $60,000 through car payments, school loans and credit card debt.

As teachers we may qualify for down payment assistance as long as both of our credit scores are above 680, which they currently are not.

Would it be better to pay down our debt or save up for a down payment on a house?

-C.

Dear C.,

First, you don’t have to decide on paying down debt OR saving for a down payment on a house. You can absolutely split your monthly excess between extra debt payments and your down payment fund.

But based on what you’ve told me, I’m inclined to think that paying down your debt will get you on the path to homeownership faster than saving for a down payment would. My reasoning is twofold.

When you apply for a mortgage, lenders look at your debt-to-income ratio — that is, the percentage of your gross household income that goes toward debt, including a future mortgage payment. Typically, lenders want this number to be 43% or lower, so by paying down debt, you’ll free up more money to use toward a mortgage payment.

The second reason is your credit scores. If you both have scores below 680, you could find it difficult to get approved for a mortgage. A 2016-17 Credit Sesame survey of 600 people who applied for a $150,000 mortgage found that 62% of those with a credit score between 650 and 700 were denied.

Considering that the average down payment assistance amounts to about $12,000, improving your credit to the magic 680 number you need to qualify could give you a huge boost in your goal of becoming homeowners.

Paying down your debt is likely to increase your score because your credit utilization ratio, or the amount of your overall revolving credit you’re using, accounts for 30% of your FICO score. The only factor that’s weighted more heavily is your payment history, which determines 35%.

Because revolving credit is what determines your credit utilization ratio, focus first on paying off your credit cards. Not only will that help you improve your scores, but it will probably save you money, since the average credit card interest rate is above 17%.

Once you’ve paid down high-interest debt and increased your credit scores, it might make sense to focus more on saving for a down payment.

There are a lot of advantages to having a larger down payment, the most obvious being lower interest rates and monthly payments. But the truth is, people are generally putting less money down than in the past. The median down payment for first-time homebuyers is just 6%, according to the National Association of Realtors.

Regardless of how you decide to prioritize paying down your debt vs. saving for a down payment, you’re smart to think about down payment assistance programs now, rather than when you’re in the frenzy of the approval process. If you haven’t already, talk to a lender now. They can make sure you know all your down payment assistance options and help you clear whatever hurdles stand between you and homeownership.

Robin Hartill is a senior editor at The Penny Hoarder and the voice behind Dear Penny. Write Dear Penny and you might see your question answered in an upcoming column.