Here's Why You Should Pay Down Debt Before Applying for a Mortgage

If there's a mortgage loan application in your future, you should know that in the process, your credit history and finances will be exposed like never before. The reason for this is simple: Your lender needs to ensure that you'll be able to repay the money it's loaning you to buy a home. And since a house is likely to be the biggest expense you'll ever face, this makes a lot of sense.

Your lender will want to know about your employment situation (including how much money you make), as well as any assets you might have (such as cash in a savings account or investment holdings). It'll pull your credit report and do a deep dive, and you'll be expected to explain any delinquent accounts or other black marks reflected in your credit score.

Your credit report also has information about your current debts, and that information combined with your income gives your lender a look at your debt-to-income ratio. If that number turns out to be a bit too high, you could be rejected for a mortgage loan.

Your debt-to-income ratio matters for a mortgage

A National Association of Realtors (NAR) study found that in 2022, debt-to-income ratio was the most common reason for a potential buyer to have a mortgage application rejected -- for almost one-third of applicants (32%), this was the culprit.

Your debt-to-income (DTI) ratio is exactly what it sounds like: A percentage that says how much of your income goes to debt payments, like a car loan, credit cards, and any other money you're paying back to creditors. If you're hoping to buy a home, a mortgage lender will consider both a front-end and a back-end debt-to-income ratio. Your front-end DTI represents how much of your income will be taken up by housing costs, and this should be no more than 28%. Your back-end DTI is all of your monthly debt payments, and this should be no more than 36%. Together, this is sometimes called the 28/36 rule.

The best way to improve these numbers ahead of applying for a mortgage is to pay down your debts, if you can. And it's worth making the attempt, because owing less will help you sleep better at night, free up more money for other expenses, and help you get approved for a mortgage on your dream house.

Try raising your income to help you pay off debt

While a lot of financial gurus will tell you that the secret to paying off debt is to give up everything you love, I'm here to dispute that. On the contrary, I found that a better way to pay off debt is to increase your income. Don't get me wrong, it's still a good idea to take a closer look at your discretionary spending and stop spending money on things you don't enjoy or don't use (neglected streaming service or random subscription box, I'm looking at you). But living on ramen noodles isn't sustainable for anyone past college age.

If you boost your income, any extra money you can bring in (less taxes, of course) can all go toward your debt. Dust off your resume and see if you can score a side gig to do in your free time. You might also be able to talk your way into a raise at your main job. And if you find a side hustle you enjoy, you might want to hang onto it long enough to build yourself an emergency home maintenance fund, too. When it comes to the costs of homeownership, the initial stage of buying the house is only the beginning.