What Debt to Pay Off First When Buying a House?

Managing existing financial obligations strategically is an important step when considering a home purchase. How debt is handled before applying for a mortgage can shape the home buying experience. Understanding how current financial commitments influence a future home loan is foundational to preparing for homeownership. Proactively addressing debt improves financial standing and enhances prospects in the housing market. This preparation involves a thorough review and adjustment of one’s debt profile.

Understanding Debt’s Influence on Home Loan Approval

Lenders evaluate a borrower’s existing debt to determine their capacity to take on a mortgage. A primary tool for this assessment is the Debt-to-Income (DTI) ratio, which compares monthly debt payments to gross monthly income. This ratio helps lenders gauge whether a borrower can manage additional housing expenses alongside current obligations. There are two types of DTI ratios: front-end and back-end.

The front-end DTI ratio focuses on housing expenses, including the projected mortgage payment, property taxes, homeowners insurance, and any homeowners association fees. The back-end DTI ratio includes all recurring monthly debt payments in addition to housing costs. These recurring debts encompass car loans, student loans, personal loans, and minimum credit card payments. Lenders often prefer a back-end DTI ratio of 36% or below, though some approve loans with ratios as high as 43% to 50% for certain loan types, such as FHA loans. A lower DTI ratio indicates less financial strain and can lead to more favorable mortgage terms.

Beyond the DTI ratio, existing debt impacts a borrower’s credit score. Credit scores are influenced by payment history and credit utilization. Payment history tracks on-time bill payments, while credit utilization is the amount of revolving credit used compared to the total available. Maintaining low credit card balances and consistently paying bills on time can improve credit scores, which lenders use to assess risk and offer interest rates. A strong credit score, such as above 620 for conventional loans or 580 for FHA loans, can result in better interest rates and overall mortgage terms.

Identifying High-Impact Debts for Prioritization

When preparing for homeownership, focusing on specific types of debt can impact mortgage qualification. High-interest, revolving debts, such as credit card balances, warrant immediate attention. The average credit card interest rate can range from approximately 21.95% to 24.35% as of early to mid-2025, significantly higher than other debt types. Reducing these balances directly improves the credit utilization ratio, ideally keeping it below 30% of the total available credit. A lower credit utilization ratio signals responsible credit management to lenders and can boost credit scores.

Installment debts, with fixed monthly payments, also play a considerable role in the DTI calculation. Common examples include car loans, student loans, and personal loans. Car loan interest rates range from 6.73% for new vehicles to 11.87% for used vehicles, while federal student loan rates for undergraduates are around 6.39% and private student loans vary from 3.19% to 17.95%. While these debts may have lower interest rates than credit cards, their monthly payments directly contribute to the back-end DTI ratio. Reducing the outstanding balance or monthly payment on these loans can free up income, making a borrower’s financial profile more attractive to mortgage lenders.

The distinction between secured and unsecured debt also matters. Secured debts, like car loans, are backed by an asset the lender can seize. Unsecured debts, such as credit card balances and personal loans, have no collateral. While both affect DTI and credit score, high unsecured debt, especially with high utilization, can indicate greater risk due to its higher interest rates and lack of collateral. Evaluating debts based on interest rate, outstanding balance, and monthly payment allows for a tailored prioritization strategy. Addressing debts with the highest interest rates first, often credit cards, can save money and improve cash flow.

Effective Debt Reduction Approaches

Once high-impact debts are identified, implementing structured repayment strategies is important. Two recognized approaches are the debt snowball and debt avalanche methods. The debt snowball method involves paying off the smallest debt balance first while making minimum payments on all other debts. Once the smallest debt is eliminated, the payment amount is “snowballed” into the next smallest debt, providing psychological momentum through quick wins. This method can be motivating for individuals seeking to see immediate progress.

Conversely, the debt avalanche method prioritizes paying off debts with the highest interest rates first. Under this strategy, minimum payments are made on all debts, but any extra funds are directed towards the debt accruing the most interest. This approach results in paying less interest over the long term, leading to greater financial savings. Reducing high-interest debt can also improve credit scores by lowering credit utilization on those accounts.

Beyond these structured methods, several practical tactics can accelerate debt repayment. Making extra payments whenever possible, even small additional amounts, can reduce the principal balance and total interest paid. Creating a detailed budget is another effective strategy, helping identify areas where spending can be reduced to free up more money for debt repayment. Exploring debt consolidation, such as a personal loan or a balance transfer credit card, can simplify payments and lower overall interest rates. This involves combining multiple debts into a single loan, which can make managing finances easier and direct more funds towards principal reduction, strengthening a borrower’s position for mortgage approval.