You want to buy a house, and why not? If you have access to the VA loan programs that can make home ownership more affordable for members of the military, what’s stopping you? Is it all that debt you’re carrying? Do you wonder if it’s smarter to get some of that out of the way before you apply for a mortgage? That’s a legitimate concern, especially if you’re saddled with high-interest credit card debts and unsecured loans. So, where to start? Save for a house or pay off your debt?
We’re only a handful of sentences into this analysis, and you can probably already guess we can’t give you a one-size-fits-all answer to that question. The right choice for you might not work for others. The best strategy will depend on your specific financial situation and, if you’re on active duty, the likely length of time you’ll be deployed where you’re thinking about buying.
However, as you read on you’ll see that we can provide some clarity on how to make the best decision. The good news? Whether you cut into your debt-load first or start saving for a down payment on a house, you’ll be on the road to improving your financial health.
Advantages and Disadvantages of Paying Off Debt First
If it seems as if the mortgage deals you’re being offered aren’t the mortgage deals you think you can handle, here’s one reason why that might be happening: Lenders see the debts you’re already carrying and structure their offers around them. Too much debt that comes with too much interest can get in between you and an affordable mortgage.
So, should you be debt-free before buying a house? Even that answer isn’t simple. Not all debt is the same, and some debt can work in your favor when it comes to getting a mortgage. The type of debt you’re carrying is one of the factors in the decision you’re about to make. The pros and cons of reducing your debt first is determined by the amounts you owe and interest rates you’re paying.
By the way, help is available for military members who find themselves too deep in debt. There are a number of military debt relief programs specifically designed for service members looking for a way to reduce their debt load for any reason, including buying a house.
Pros of Paying Off Debt First
Let’s assume your endgame is home ownership and you need to know the most economical way to get there. The best place to start is to address your high-interest credit card balances and any other unsecured loans such as student loans and personal loans that didn’t require collateral. Paying off some of those debts will make you a more attractive mortgage borrower. Here’s how it works:
- Your credit utilization ratio will improve as you pay off credit card debt. Your ratio is determined by dividing the amount of revolving credit you’re using by the total amount of credit you have available. The lower your credit utilization ratio is, the higher your credit score will be. And the higher your credit score is, the better your mortgage terms will be.
- Lenders also look at something called your debt-to-income ratio (DTI), which, as you might suspect, compares how much you owe to how much you make. Your DTI goes lower when you pay off a credit card or any other loan, and a low DTI, like a low credit utilization ratio, can eventually lead to a home loan with better terms.
- What you’re after is the best interest rate you can get on a mortgage. A good credit score (anything over, say, 670 on the 300-to-850 range) and a low DTI (say, 35% or less) can save you boatloads of money on the interest you’ll pay over the length of the loan. Paying off those high-interest debts before you sign on the dotted mortgage line is the key.
- At the end of the day (or week or month or year or however long it takes you to pay down those debts), you’ll have freed up more money to save for your down payment and closing costs, and those savings will accumulate more quickly. That can mean you’ll have access to a bigger, better house that you can buy on friendlier terms.
Cons of Paying Off Debt First
If you aren’t careful about how you pay off your debts and which debts you try to reduce or eliminate, you can undo some of the positives we just mentioned. If the purchase of a house is the goal, misdirected debt payments could be counter-productive. Here are some of the things that could work against you.
- As we’ve already mentioned, being able to turn the key to the front door of your new house for the first time might depend on your ability to pay down the high-interest debts with biggest balances you’re carrying on credit cards and unsecured loans. But reducing other sorts of debt, for which you aren’t paying much interest and your balances are reasonably low, won’t significantly move the needle in your credit score. That money probably would be more useful in your down payment fund.
- You want to pay off your debts, but even if you can, you shouldn’t close out your accounts. Why? Because paying off a credit card in full and closing out the account can have a negative effect on your credit score, especially if you don’t have many other active credit accounts that the credit bureaus can monitor to determine your rating. The dip in your credit score probably will only be temporary, but if it’s still in place when you apply for a mortgage, it could hurt you.
- What if the perfect house unexpectedly comes onto the market, say, right now, and you’ve been using a lot of your available resources to pay off debts? You might not have the funds you’ll need for the down payment. Unfortunately, somebody else does and snaps the house up.
- Here’s another way that delaying your down payment savings in favor of reducing your debt can hurt you: As a general rule, a 20% down payment on a conventional home loan will relieve you of the obligation to buy private mortgage insurance. Again, it’s timing. If the right house becomes available before you’ve saved enough for that 20% down payment, you’ll likely be paying up to 2% of the balance of your loan in mortgage insurance every year. It gets added on to your monthly mortgage payment.
Advantages and Disadvantages of Saving For a House First
The nice people who decide if they’re going to loan you money for a house are going to want to know all about your financial situation. They’re going to look very hard at your credit history, your income, your assets, and (of course) your debts. When they’re done crunching all those numbers, they’ll either give you an immediate thumbs-down or they’ll make a mortgage offer. The offer will include how much they’re willing to lend you, how much interest they’ll charge you, how long they’ll give you to pay it back, and how much of a down payment they’ll want. It can be a sobering experience. Obviously, you want to put yourself in the best position to get a mortgage you can handle, but getting to that position is a delicate balancing act.
Plus, if you’re on active duty in the military, you’ll want to make sure the decision to buy a house sooner rather than later lines up with your long-term financial and lifestyle goals. That isn’t always easy if your deployment at your current base will be for two years or less after you buy.
As with paying off your debts first, there are pros and cons to salting your money away for a down payment.
Pros of Saving For a House First
Rents are rising (rents are always rising, aren’t they?), including for members of the military who live off base. And that monthly rent check to the landlord probably isn’t doing as much as a mortgage payment would to help build your successful financial future. Here are some reasons it might make sense to start saving for a house right away:
- Regularly paying your rent on time might be good for your credit score, but it won’t build you the equity that a regular mortgage payment does. The sooner you start saving for a down payment, the sooner you can use that money to actually get into your own house and start paying down the home loan balance. That’s how you increase your equity in your home.
- The bigger the down payment you give a lender, the lower the interest rate on your mortgage will be. That’s a factor on the plus side of starting a down payment savings account as soon as you can.
- If you can grow your down payment to 20% of the value of the home you’d like to buy, you probably can avoid having to buy private mortgage insurance. That could save you thousands of dollars over the length of your mortgage. In most cases, putting together a down payment that big takes time. By committing your resources to saving for a house before you worry about paying off debts, you can shorten that time.
- You shouldn’t overlook the peace-of-mind factor that might come with home ownership. Getting into your house as soon as possible can be a difference-maker in a lot of ways, assuming you can do it without defaulting on your debts.
Cons of Saving For a House First
The obvious drawback to putting money away for a house is that you still have bills to pay while you’re doing it. Can you manage both and continue to enjoy the kind of life you want? It costs money, lots of it, to buy a home and start living in it. A down payment. Closing costs. Mortgage insurance. Whatever repairs and upgrades you want or need to make. And, of course, that monthly mortgage payment, which probably will be larger than the rent you were paying for your former digs.
There are other downsides, too:
- Because you’re focusing your available resources on saving for a house instead of paying down your outstanding debts, your debt-to-income ratio (DTI) could be too high to get the kind of mortgage you need for the home you want.
- Your house savings might keep you from addressing the high interest rates you’re paying on your credit card bills. That could become a serious financial inefficiency.
- Putting money away for a house won’t do anything to help your credit score. That money doesn’t start positively impacting your credit until after you have the new home and are making regular mortgage payments on it. And if saving for a house means you have to let your credit card balances grow, your credit score will suffer.
- The sacrifice it takes to save up to buy a house might not be worth it if you’re in the military and won’t be able to live in it long enough to build substantial equity. The median length of time owners stay in their homes is 13 years, according to a study from the National Association of Realtors, and it’s difficult to do that in the military. If you’re going to be re-deployed in the foreseeable future, you won’t have that kind of time to chip away at your mortgage unless you find a way to maintain ownership from wherever your next station is.
Considerations for Deciding to Pay Off Debt or Save For a House
Have we confused you? Too many questions and not enough answers? Here’s something that might help. It’s an all-in-one-place list of some of the factors you should take into account as you’re thinking about whether to pay off debt first or start saving for a house. We’ve mentioned many of them already, but they might be useful in this form if you apply them to your specific financial circumstances.
- Interest Rates: Check the interest rates on the debts you’re currently carrying. If they’re high, then it’s probably wiser to pay them down first before you concentrate on saving for a down payment. What’s too high? Anything over, say, 16% on your credit cards and 10% on whatever personal loans you’ve taken out.
- The balances on your debts: This is pretty simple. If they’re big, you’ll have more trouble convincing lenders you can be trusted to meet your new mortgage payments. So, make paying off those debts the priority. If the balances are low, you can perhaps get them paid off while you are simultaneously saving for a down payment.
- Your Credit Score: The higher the better if you’re looking for a good mortgage offer. You should be in good shape if your credit score is above 670 on the scale of 300 to 850. If it isn’t, then you might be better off trying to bump it up by paying off some of your debts and decreasing your credit utilization ratio to something less than 30%.
- Your Debt-to-Income Ratio: This is the percentage, remember, of how much you owe in relation to how much you make. The magic number as far as lenders are concerned is 50%. Anything higher than that and chances are you won’t be approved for a mortgage, and anything even close to 50% could be problematic, too. If that’s where your DTI is, then by all means start this process by paying off some debts and reducing that ratio.
- The down payment: Take a realistic look at how much you think you’ll be able to save to put down on a new house in the time you’re willing to wait before you buy. If you’ll be able to stockpile 20% of the value of the home you want as a down payment, you can reduce the interest rate on your mortgage and probably avoid having to buy mortgage insurance. Your monthly payments will be lower that way, which is a good reason to concentrate on saving for the house first.
- Market timing: Keep an eye on what’s going on with real estate where you want to buy. Is it a buyer’s market or a seller’s market? In a buyer’s market, there will be plenty of properties available and housing prices and mortgage rates will be low. You’ll want to move more quickly, which means prioritizing saving for the house. A seller’s market occurs when there are fewer homes for sale, which drives up prices. You might want to wait that trend out if you can and commit to paying down your debt load.
- The size of your current emergency fund: If your emergency fund is robust enough to get you through three to six months of essential living expenses in the event of an unexpected crisis, congratulations! You can use your excess money to pay off debts or save for a house. But if you aren’t comfortable that you could survive a sudden financial emergency, then it’s advisable to direct some of those excess dollars into that fund before you do anything else.
Is It Better to Pay Off Debt or Save For a House?
The right decision will depend on your specific financial circumstances, especially the kind of debt you’ve already accumulated. To get to the wisest choice, you’ll need to take stock of how much you owe on your credit cards, your unsecured loans and your other high-interest debts. And then you’ll want to factor in the health of your current credit score and how much house you’d like to buy.
Once you have a strong sense of where you stand financially, here are the conditions that suggest you’d likely be better off if you pay off your debts first:
- You already owe a lot of money and are having difficulty keeping up with those payments.
- Your credit score is low (remember, it’s a 300-to-850 range) and/or your debt-to-income ratio is high.
- Your current debts carry high interest rates.
- The real estate market is tight where you want to buy. There aren’t many homes for sale and the ones that are available are expensive.
- You don’t expect to stay where you’re currently stationed beyond the next couple of years.
And here are the factors that indicate you could begin to save toward buying a house:
- You’ve established that you can meet the payments on the debt you’re already carrying and have enough left over to put away for a down payment and, eventually, the monthly mortgage payments.
- Your credit score is safely over 670 and your debt-to-income ratio is safely under 35%.
- You already have an emergency fund in place that will get you through three-to-six months of a financial crisis.
- Mortgage interest rates are low in the housing market where you want to buy.
- You can expect to be able to stay in your current area for some time into the future.
About The Author
Michael Knisley writes about military related finance topics like military pay, security clearances, and Tricare for Military Money. Michael was an assistant professor on the faculty at the prestigious University of Missouri School of Journalism and has more than 40 years of experience editing and writing about business, sports and the spectrum of issues affecting consumers and fans. During his career, Michael has won awards from the New York Press Club, the Online News Association, the Military Reporters and Editors Association, the Associated Press Sports Editors and the Sports Emmys.
- N.A. (ND) How Closing a Credit Card Account May Impact Credit Scores. Retrieved from https://www.equifax.com/personal/education/credit-cards/how-closing-credit-cards-impact-credit-scores/
- Kearns, D. (2023, May 16) How to Choose the Best Mortgage for You. Retrieved from https://www.investopedia.com/mortgage/mortgage-guide/how-to-choose-best-mortgage/
- N.A. (2022, November 7) Should You Buy A Home While On Active Duty? Retrieved from https://veteran.com/buy-home-active-duty/
- Evangelou, N. (2020, January 8) How long do homeowners stay in their homes? Retrieved from https://www.nar.realtor/blogs/economists-outlook/how-long-do-homeowners-stay-in-their-homes
- Akin, J. (2022, May 8) Buyer’s Market vs. Seller’s Market: What’s the Difference? Retrieved from https://www.experian.com/blogs/ask-experian/buyers-market-vs-sellers-market/
- Rodrigues, G. (2021, March 31) Seller’s Market 101: Is Your Real Estate Market Hot or Not? Retrieved from https://www.homelight.com/blog/what-is-a-sellers-market/