Best use of a bonus for buying a home this year – save it, or pay down debt?[ Edited ]
It is likely that I will be receiving a bonus from work. I want to buy a house this year, but have credit card debt. Is it best to pay down as much credit card debt as possible, then save for a house down payment? What criteria should I use to evaluate the best option of either saving or reducing debt?
There are a number of factors that could impact your “best” approach. And they all revolve around which aspect of the home buying process you’re most focused on.
Focused on Your Credit Score?
If your credit score is your biggest concern, then paying down as much debt as you can, as soon as you can, might be a good way to bump up your number. I say “might” because this really depends on your overall credit profile. However, if you’ve got pretty high balances relative to the card limits (known as a utilization ratio) then knocking those balances down can sometimes provide a nice boost to your score.
Focused on Debt-to-Income Ratio?
One factor mortgage lenders will consider before giving you a loan is how your total monthly debt payments stack up against your monthly income: your debt-to-income ratio. Generally speaking, the lower this number is the better. Less than 36% is a good target. To calculate yours:
- Total your monthly debt. Include your house and car payments, student debt, credit cards, etc.
- Take your annual salary before taxes, including bonuses, and divide by 12 to determine your pretax monthly income.
- Divide your monthly debt by your pretax monthly income.
Naturally, paying down your debt can help reduce this ratio and make you a more attractive borrower.
Focused on Down Payment/Mortgage Payment?
Taking a different direction, if your credit score and debt-to-income ratios are in good shape, you might be focused instead on trying to get a more affordable mortgage payment by reducing your loan amount or avoiding private mortgage insurance. If this is the case, keeping the cash so that you can have a larger down payment might be the right way to go for your situation since you’d be borrowing less.
A Word of Caution
Finally, whatever you decide to do, I urge you to step cautiously into the world of homeownership. It’s such a big financial commitment that you want to make sure your ready and I’m honestly a little concerned that you’re going into this when you’re already saddled with credit card debt. To be clear, I’m not saying that you need to be completely debt-free before you buy a home, I’d just recommend that you be really honest with yourself about whether or not you’re really in a good financial place to take such a big leap. Maybe you’re fine but in some cases it’s better to wait until you’re on more solid financial footing.
For more information and guidance on the home buying process, please check out the Home Circle™ section of usaa.com. You’ll find a lot of helpful tools, calculators and other resources there to help you get off on the right foot when buying a home.
Thanks so much for your question and best of luck to you!