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It’s a move that might pay off.
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If you owe money on a personal loan, you’re in good company. As of the fourth quarter of 2022, U.S. personal loan balances reached $220 billion, according to TransUnion. That’s up from $167 billion a year prior.
Note that owing money on a personal loan isn’t necessarily a terrible thing. Often, these loans come with competitive interest rates attached to them that make them reasonably affordable. And because these loans come with fixed interest rates, your monthly payments are nice and predictable.
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But if you’re planning to buy a home, you may want to consider paying off your personal loan balance before applying for a mortgage loan. Here’s why.
1. It might help you qualify for a home loan
Mortgage lenders look at different factors when deciding whether to approve an application or not. One factor is your credit score. The higher it is, the more likely you are to get approved for a mortgage, and at a more favorable interest rate.
Another big factor that goes into mortgage approval is your debt-to-income ratio. This ratio measures the total amount of your monthly debt relative to the amount of money you earn.
The lower your debt-to-income ratio, the more likely you are to get approved for a mortgage. So if you can pay off your personal loan ahead of your mortgage application, you’ll have a lower debt-to-income ratio to present.
2. You’ll have one fewer debt to deal with
Factoring a mortgage into your budget isn’t an easy thing to do. And it’s not just your mortgage payments you have to worry about when you buy a home. There’s a host of added expenses you’ll be on the hook for, from property taxes to homeowners insurance to maintenance to repairs.
If you pay off your personal loan before signing a mortgage, you’ll free up that much more room in your budget. And that could make it a lot easier for you to adjust to your new set of housing expenses.
Just as importantly, if you’re able to rid those personal loan payments from your list of monthly obligations, you’ll lower the risk of falling behind on any of your bills. Remember, the cost of owning a home has the potential to be higher than you expect, so the more wiggle room you’re able to give yourself, the better.
Should you pay off your personal loan before getting a mortgage?
Carrying personal loan debt is something you may end up doing for many years. But if you’re making plans to apply for a mortgage, paying off your personal loan beforehand could be advantageous.
That said, the money to pay off a personal loan will have to come from somewhere. You might have it sitting in your savings account. But when you buy a home, you need plenty of money on hand for unplanned bills and emergencies, like having to suddenly replace your water heater or roof. So you actually shouldn’t pay off your personal loan early if it means leaving yourself with little to no cash reserves for unplanned bills related to your new home purchase.
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