Debt when buying a home

Q – I have a few college loans, a car payment, and a few thousand-dollar balance on a credit card. We want to buy a house, but I worry our credit score is too low to qualify for a mortgage. Which debt should be reduced before buying a house?

A – While mortgage lenders have minimums on credit scores and debt-to-income ratios, they only look out for their interests when loaning you money, not whether it’s good financially for you. Just because you can doesn’t mean you should. Meaning, you need to examine not just your debt, but how much emergency savings you have, the stability of your income, and other expense commitments. The answer might be that some other things need to be improved before buying a house, such as having more emergency savings and paying off all credit card debt, which are my top suggestions. 

For the debt, I would say the first step is to examine every current debt, the terms of the type of debt, what it costs you in interest, and the risk with that particular debt. For example, you can’t get rid of a college loan, but you can sell a car and pay off the debt. You can refinance some debt more easily than others to lower or shorten the payment. In general, Dad would say, “What can you do to make yourself the lowest risk in the eyes of the lender?” Probably, show you’re always paying on time, are consistently reducing the debt outstanding, and paying more than the minimum amount. That would show you understand the cost and risk of higher debt, and have the resources and discipline to manage your money well.

Finally, you should be prepared to "stay the course" for at least 5 years of homeownership to reduce the risk of the additional debt. Buying a house changes your financial risk significantly at first, but decreases over time due to paying down the loan, paying down other loans, higher income (hopefully), increased savings, and equity built up in your house.  So, those first few years are risky; thus, it's best to stay the course to lower the risk over time.