Have you asked yourself the question, should I pay off all of my debts before I buy a home? This seems to be a situation that keeps appearing with some of our clients. They plan on buying a home and decide to pay off all of their credit cards and any kind of loans they have in order to qualify for the biggest loan possible. While paying off credit cards can be good, paying off car loans, student loans, or any other kind of “installment” debt can be a bad idea before buying a home.
You may be asking “Well why is that? Isn’t staying in debt a bad thing?” I’ll explain why staying in debt, within reason, can help you in your home buying purchase.
I want to say first off that you’re mostly correct in believing staying in debt is a bad thing. Growing up many of us were told to not use credit cards, or try and buy everything with cash if you can, because you don’t want to pay interest. While this is true from a budget standpoint, when you’re buying a house, you want to have an active history of being able to borrow money and responsibly pay it back.
So what does an active history mean?
When lenders go through your credit report, they like to see at least 3 active trade lines open on your account for at least 12 months. These could be items like student loans, credit cards, personal loans, car loans, current mortgages, or anything positive that has been reported for the past 12 months and still shows that it is open. These “active” trade lines show that you are able to pay back your debts that you have made, with a certain level of responsibility.
We’ve actually had some clients come in and say that they knew their credit was good and they didn’t need the accounts open any longer so they decided to close everything.
DO NOT DO THIS!
While this shows that you have been able to manage money in the past, it doesn’t say you are able to manage it currently. If lenders don’t see 3 active trade lines we usually have to ask for items of soft credit and this can prolong the loan process or even disqualify you from certain loan programs.
Here are four quick guidelines to go through before you think about paying off a loan or closing an account.
- If you plan on paying an installment loan off completely, contact your lender first! You may save a little bit of interest by paying it off now, but you may find out you cannot qualify for a home loan or buy your dream house.
- If you are paying off a credit card, make sure not to close it. You can always leave it at a zero balance and close it AFTER you have gone through the whole process and closed on your new house. Also, you may need the cash to get the loan.
- If you do happen to have a lot of different loans and credit card accounts showing a 12 month or more history on your credit report you may close some of them but contact your lender first to guide you what is best to get you the best loan.
- Always contact your lender and explain your current situation and what you plan on doing. A good lender will help develop a plan on what you need to do in order to get a great home loan!
Hopefully this article has answered some of your questions about paying off all of your debt before buying a home. If you have a unique situation or want to discuss your scenario, please don’t hesitate to call us or fill out our quick inquiry here. We would love to help you get a great home loan!