Why this question matters for homebuyers
Why does it matter if you choose to pay down debt or invest in your homeownership goals? Your debt, credit score and down payment savings are all key to getting your mortgage approved with manageable terms.
On the one hand, debt affects both your debt-to-income (DTI) ratio and credit score—financial indicators that lenders look at to see how well you handle repayments. If your DTI ratio is too high or your credit score is too low, you might face higher interest rates or struggle to get approved.
On the other hand, saving up for a bigger down payment can help you borrow less and maybe even skip private mortgage insurance (PMI), saving you money each month. Striking the right balance between paying off debt vs. saving can open up more mortgage loan options and improve your chances of earning a better interest rate. But which goal should you tackle first?
When paying off debt comes first
Focusing on debt first can make sense in many situations.
Reducing high-interest debt
If you're carrying debt with high interest, like from credit cards or personal loans, consider tackling that before saving aggressively for a house. Those steep interest payments go directly to the lender and don't help reduce your debt or boost your savings. As a general rule, focus on paying off debt with the highest interest rates. Once you clear that debt, you'll free up extra cash to build your savings.
Improving your debt-to-income (DTI) ratio
Lowering your debt is a surefire way to improve your DTI. Lenders look at this ratio to see how much of your gross monthly income is tied up in debt payments. Most lenders like to see a DTI ratio below 36%, though some allow up to 43%. If yours is higher, especially over 50%, you may be seen as a risky borrower who could struggle with payments. While there are home lending options that accept higher DTI ratios, you may not get favorable loan terms. Ultimately, if you have a high DTI ratio or find it challenging to keep up with bills, you should focus on reducing your debt first.
Boosting your credit score
A better credit score improves your chances of qualifying for a home loan and earning favorable terms. If debt is dragging down your credit score, it may be due to high credit utilization. That’s the amount of debt you have compared to your available credit. To reduce credit score impact, aim for credit utilization below 30% by paying down high-interest debt. Most conventional loans require a minimum FICO® score of 620, but requirements will vary by loan and lender.
When saving for a house takes priority
When your debt is under control, you have more freedom to save for a down payment and react to market conditions.
Comfortably managing debt
If your DTI ratio and credit score look strong and you feel comfortable juggling your current debt, it might be a good time to save for that down payment. You don’t have to be debt-free to start; many people afford a home with lower-interest debts like student loans. Just be mindful of your other financial goals and obligations. No matter what you’re paying off or saving toward, most experts recommend that you always have an emergency fund that covers 3–6 months’ worth of expenses.
Avoiding PMI with 20% down
Some loans require you to pay private mortgage insurance (PMI) if your down payment is on the smaller side. If you want to shave down your monthly mortgage bill, steering clear of PMI can be a good strategy.
For conventional loans, you need at least 20% down to avoid mortgage insurance costs. If you get a government-backed FHA loan, you’re automatically on the hook for mortgage insurance.
Just remember to explore your mortgage options because not all loans require a 20% down payment or come with PMI strings attached. Even if you can’t avoid PMI entirely, you have the option to refinance down the line for new terms or a different loan.
Seizing market opportunity
In today’s competitive housing market, it’s smart to stay on top of current interest rates and home prices. Lower rates can help you afford a loan, but a low-rate environment can also turn into a seller’s market—when an influx of buyers causes a spike in home prices.
The best thing you can do is keep an eye on trends and forecasts. If it looks like you should purchase sooner rather than later, you may want to focus on saving. But if you’re concerned about rates, paying off debts could help set you up for better mortgage terms in the future.
Balancing both: Debt payoff and savings at the same time
If you’re still split on whether to pay down debt or save, splitting could be the solution. With the right financial approach, you can work toward both goals. A popular budgeting method is the 50/30/20 rule. Here's how it breaks down: 50% of your income goes to essentials like housing and groceries, 30% is for your wants, and the remaining 20% gets split between saving and debt repayment. This way, you can work toward homeownership while keeping debt in check.
Before you go all in on a strategy, pressure test potential ideas. Plot out a few different scenarios and see how they affect your debt and savings over time. Use our Affordability Calculator to estimate how much house you could afford with different debt amounts and interest rates. You can also unpack the costs that go into budgeting for a home with our mortgage affordability guide. Ultimately, checking in with a financial advisor can help you feel secure in your decisions and chart a clear path forward.
Next steps toward homeownership
When you’re confident in your financial profile and just about ready to make offers, you’ll want to get preapproved for a loan. Preapproval gives you a good picture of what you can afford. It also shows sellers you're a serious buyer with financing already in the works, which can make your offer more competitive. Preapproval streamlines the closing process by getting a lot of the paperwork out of the way early on. All in all, it gives you and the seller peace of mind.
