Lenders consider many factors when trying to decide whether to approve a homebuyer for a mortgage, including their debt-to-income ratio (the amount of debt payments someone’s making relative to their monthly gross income). If you’re saddled with credit card debt and student loans, paying them down can make qualifying for a home loan easier. But which one should you wipe out first?
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Credit Cards and Your Credit Score
Credit cards are revolving lines of credit, meaning that the amount you owe can change from month to month. The most important things that affect your credit score are your payment history and your credit utilization ratio (that’s how much of your available credit line you’re using).
It’s important to make sure that your credit utilization ratio doesn’t exceed 30%. Having multiple credit cards that are close to being maxed out can raise your credit utilization ratio and lower your credit score. Paying down your balances or eliminating them completely, on the other hand, can have a positive effect on your score.
How Student Debt Affects Homebuyers
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Student loans are installment loans, meaning that they’re paid off in installments according to a fixed schedule. It’s important to make sure you’re paying your student loans on time, since a single late payment can take 100 points off your credit score.
Making on-time payments regularly, on the other hand, can improve your credit score. Just keep in mind that you won’t be able to start reducing your principal loan balance until you’ve paid off enough interest.
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Which One Should You Attack First?
If you’re torn between chipping away at your credit card debt and paying off your student loans, there are three specific things you can zero in.
First, there’s the interest rate. Unless you’ve got private student loans, chances are the annual percentage rate (APR) on your credit cards is a lot higher than your student loan interest rate. That means that if you take a long time to pay those cards off, you’ll be wasting money on interest. Tackling your credit card debt as soon as possible could save you some cash over time.
It also helps to think about how much money you owe. If you owe a few hundred bucks on a couple of credit cards with high credit limits, they might not have a significant impact on your credit utilization ratio (or your credit score). On the other hand, if you’ve barely made any progress toward paying off your student loans, chipping away at those balances could help you raise your score.
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Finally, consider how much money you’re shelling out on your respective debt payments each month. While you can be eligible for a qualified mortgage with a debt-to-income (DTI) ratio of 43% or less, it’s best to keep your DTI below 36%. If the minimum payments on your student loans are fairly low but your credit card minimums are eating up a big chunk of your salary, figuring out which one to ditch first should be a no-brainer.
If you’re determined to eliminate your credit card debt first, here’s one last tip. Closing your accounts once they’re paid off is a bad idea. Closing unused accounts can hurt your score, so you might want to wait until after you’ve purchased your home to consider getting rid of your cards for good.
This article originally appeared on SmartAsset.com
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