 Should we pay off our credit cards before saving for a down payment? Or is there a point where it makes sense to make the minimum payments on our cards and bank the rest for a down payment?"
Credit cards play a complicated role in preparation for a home purchase. On the positive side, a history of timely payments on credit cards builds a positive credit history and a correspondingly high credit score. That's an important plus when you enter the home loan market.
On the other hand, if there are any indications of financial stress in your credit card history, it will reduce your credit score, even though you may be making all payments on time. Indications of stress include new card issuances a high utilization ratio, these are the ratios of balances to maximum balances. As you plan ahead for a home purchase, get your utilization ratios below 50 percent and avoid taking out new cards.
Credit cards can also affect your ability to qualify for the loan you want because the required payments are added to the payments associated with the mortgage in determining how much you can afford. The "total expense ratio" calculated by lenders and used in qualifying borrowers is the sum of the mortgage payment, property taxes, homeowners' insurance premium, and other debt service, including credit cards, all divided by the borrower's gross income. However, if you can keep your total debt service payments below 8 percent of your gross income, it will not limit the amount you can borrow.
You need some cash to buy a house, for down payment and settlement costs. Generally, the larger the down payment the lower the cost of the mortgage, but the relationship is notched, not smooth. If you go from nothing down to 3 percent down, the cost of the mortgage will drop; if you go from 3 percent to 4 percent, it won't, but from 3 percent to 5 percent it will. While there are exceptions, the major notch points are 0 percent, 3 percent, 5 percent, 10 percent, 15 percent and 20 percent. For someone in your position, 3 percent is a reasonable target.
In sum, when your card utilization ratios are below 50 percent, your total debt service payments below 8 percent of your gross income, and your target down payment is in hand, you are ready!
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