Question Details

Mita, Home Buyer in Michigan

What will better help in getting financed - paying off revolving credit or installments loans first?

Asked by Mita, Michigan Sat Oct 6, 2007

We have great credit 780 and we want to qualify for a mortgage, but we feel our debt will hold us back. Since our installment (auto) loan tends to carry a larger monthly payment ( and a slightly higher interest rate) than our credit cards what would make sense if we were to tackle one debt vs. the other? We have enough funds saved to take out one of the above mentioned.

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9
Mita,

I was invited to comment and am pleased to offer some basic advice. I may contradict what some of the real estate agents have told you so I don't mean to sound petty.

You do have an excellent credit score, however, the days of great credit scores getting you the best loan terms are gone. Now, more than ever, lenders are returning to old school underwriting and the ability to repay the loan, as measured by a debt to income ratio, are essential.

NB- My advice is general because prescribing a specific solution, on a website like Trulia, is like treating a disease on WebMD. The absolute best thing you can do is have a mortgage planner help you with this personally. I'm happy to advise you; click my link for contact information.

1- Pay down but don't pay off the installment debt. If your balance reflects less than 12 payments due, it will not be counted in your ratios by an underwriter. The lower balance, when reflected to the "high limit" will maintain your excellent credit score.

2- The revolving debt can be strategically paid down to reflect lower payments. If you pay an account down do NOT close the line of credit; that will eradicate "available credit", causing the algorithm used by the credit scoring models to think that you are less credit worthy than before.

You've done an excellent job managing credit to date. With personalized counseling, you'll position your self for the best home loan available.
4 votes Thank Flag Link Sun Oct 7, 2007
Your mortgage counselor will want to analyze the percentage of down payment that you intend to make as well as the debt to income ratio. I am going to introduce a complicated bit of math here for illustration sake that I label as an "unblended rate" comparison.

This math exercise assumes that an 80% Loan to value loan (Purchase with 20% down) can be obtained for a note rate of 6%, I then assert that the same borrower can qualify for a 95% loan (only 5% down). Due to the higher loan to value ratio (and perceived risk by the lender) the interest rate for the 95% loan is 7%

If I "unblend" the 7% rate on the 95% loan. I discover that the first 80% of the purchase price is still at 6% but the additional 15% of purchase price is actually at a cost of 12.333%

If the borrower has to borrow the higher loan percentage because they want to use most of their down payment money to pay off their automobile and credit cards, one of the questions I would ask, is: " Are the interest rates of your car loan and credit cards lower or higher than the 12.3%"

This math problem does not contradict the excellent advice given earlier by Brian, Ute, Sylvia, and the others. What is best for you personally may not be the best for someone else in a nearly (but not completely) identical situation.

.
3 votes Thank Flag Link Sun Oct 7, 2007
Jim Walker, Real Estate Pro in Carmichael, CA
MVP'08
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Hello Mita:

Having a 780 credit score while carrying both auto loan and revolving credit card loan should not be a problem for you because 780 is a great credit score. Perhpas that money can be saved for downpayment, closing cost, etc..

However, I am not a mortgage broker; so, I contacted a couple of mortgage experts in Trulia for you. Hopefully they will come and give you their professional opinion on this.

Best,
Sylvia
1 vote Thank Flag Link Sun Oct 7, 2007
Sylvia Barry,…, Real Estate Pro in Marin, CA
MVP'08
Contact
Hi Mita. My recommendation would be that you check with an experienced mortgage broker. Lenders look at the overall debt to income ratio and also how your debt is distributed. For instance, if you have several credit cards and you have maxed out one, but have nothing on the other, it looks worse than if you have distributed the debt more evenly among all credit cards. Since you have excellent credit scores, the distribution factor may not weigh so heavily.

I am assuming that the auto loan is already amortized and I would check to see whether paying down the principal will automatically lower your monthly payment or whether the lower principal will just mean that you'll pay off the remainder sooner. For instance, when you have a fully amortized mortgage, paying off the principal just shortens the life of the loan, but does not affect the monthly payment. You'd also want to make sure that there's no prepayment penalty on the auto loan. I would not want you to pay down the car loan and then find out that it did not have the desired effect.
Checking with a mortgage consultant first will also help you decide if you have to do anything. The mortgage consultant may advise you that it's better to use your savings to buy down the interest rate on your future home loan or to put more down on the house to avoid having to pay private mortgage insurance. If you end up paying down the credit card balances, you'll free up additional credit for future use while paying down the auto loan does not have the same benefit. Good luck to you and it would be great if you came back to Trulia to let us know what the mortgage professional recommended.
Web Reference: http://www.go2kw.com
1 vote Thank Flag Link Sat Oct 6, 2007
Ute Ferdig -…, Real Estate Pro in New Castle, DE
MVP'08
Contact
I would be very carefull about doing anything until you have spoken to a good loan officer. I recommend speaking to somebody that is a Cerfified Mortgage Planning Specialist.
You will see CMPS next to that persons name on a buisiness card.

Every situation is different and the formula for calculating a credit score is very complex and almost impossible to understand (especially when you try to use common sense!)
0 votes Thank Flag Link Wed Nov 7, 2007
It doesn't really matter, what is more important would be to attack the debts that have the highest payments and or lower you credit balances below the 50% available credit limit. Reducing your debt load and improving your credit scores never hurt anyone in getting a home loan.
Web Reference: http://getprequalified.com
0 votes Thank Flag Link Wed Nov 7, 2007
get rid of the revolving credit asap
Web Reference: http://www.iansellsnola.com
0 votes Thank Flag Link Sat Oct 6, 2007
Lenders look at anything over 720 as stellar credit.

If your income substantiates it you do not have to wory about paying off any other debt unless it affects your debt to income ratio.

You are fortunate. Buy a home and ride the wave up... yes this is coming... be ready for it.
0 votes Thank Flag Link Sat Oct 6, 2007
Your credit score is already excellent. The next thing your mortgage company will look at is your debt to income ratio. If it is too high that can cause you problems. If you pay off your car loan because it is high you will probably help your ratio considerably. Give a mortgage company a call and ask them how much of a difference it would make. That way you will be able to make an accurate decision based on fact.
0 votes Thank Flag Link Sat Oct 6, 2007
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