Is it a good idea to pay off our installment loans before applying for a home loan?

Asked by Charmed077, Germantown, MD Mon Jan 31, 2011

My husband and I have 3 installment loans currently open (2 auto loans and 1 unsecured consumer loan). They each have a balance of less than $5000 and I had planned to have them all paid off by the end of the year by making extra payments. I'm now reading that some banks require a minimum of 4 open and active tradelines. While we are going to be aiming for an FHA loan which I know does not have this requirement, is it still a good idea to pay these off early? The only other open and active tradeline we would have would be our credit card if we closed these other accounts. Even if FHA does not require 4 open tradelines, could closing these accounts have a negative (or even positive) impact on our credit scores? Our debt to income ratio is pretty great (less than 12%) so whether we pay them off or not, our DTI wouldn't really be impacted. Thanks for any advice!

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Mon Jan 31, 2011
I think another concern is downpayment / closing costs... would paying off the accounts still allow you to pay for downpayment plus closing costs on your new home? If you could save that 3 accounts at $5,000 = $15,000, maybe you would qualify for 10 or 20% down which would potentially open up new loan options.

A good rule of thumb is that banks like to see 3+ active / open tradelines, but there is no specific standard requirement. You could possibly add a verification of rent or utilities to show credit.
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Mon Jan 31, 2011
Typically installement loans don't help a great deal improve the credit score. I was going to mainly say that it would help you buy more home but if the DTI is that low it's really not a worry. What I recommend is getting the credit score from ONE lender and then using that report if you want to shop lenders. I can't make recommendations without seeing a credit report. If the score is where you want/need than you only need to maintain. If it's low then we have work to do and that might be the time to pay things off/down but again paying off installment loans isn't usually a score raiser. Hope this helps, let me know if you need more.

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Dan Tabit, Agent, Issaquah, WA
Mon Jan 31, 2011
Thanks for asking the question before taking action. Sometimes what seems logical to most folks works against them when it comes to banks.
DO NOT close any accounts! Having credit is the key to getting credit. The best credit you can have prior to getting a mortgage are accounts with lower balances, appx. 1/3 their limits, and paid on time. This demonstrates you can live with temptation and are responsible.
While paying the accounts off by the end of the year is a laudable goal, it could well cost you. Rates and prices in today’s market have increased home affordability. Where things will be in 12 months is anyone’s guess, but should either prices or more likely rates increase, you may be at a disadvantage in what you can buy.
Whenever possible I prefer to meet with my clients as early in their thinking process as possible. If we are days, weeks, months or even years out, we can map out a strategy to position them for a great decision. I would strongly suggest you meet with a local lender who can discuss your plans early and advise you as to which accounts to pay down, and by how much before you proceed. You will need some down payment and closing costs too, so it may be wiser to save some of your money for these items, rather than be paid off completely.
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