My wife and I would like to buy a house in the next 12 months and have about $1,000 extra a month to either save for a down payment or pay off our existing debt. The houses we're looking at are roughly in the $175,000 range and we have about $11,500 saved already. We also have about $35,000 in student loans, car loans and credit card debt. We could put a real dent in the debt with this money, but I also feel that if we save for a down payment, our interest rate and monthly payments would be lower. What's your suggestion?
You're right on all counts, and what you should do depends a lot on the specifics of your situation.
Your savings now equal about 6 percent of your target home price. If you saved an additional $12,000, says mortgage expert Allen Bond, that would boost you well above the 10 percent mark. If you can make a down payment of at least 10 percent, you usually qualify for either a smaller private mortgage insurance payment or a lower rate if you're doing what's known as a piggyback loan - a regular 80 percent mortgage plus another loan for the additional 10 percent, says Bond, president of the California Association of Mortgage Brokers' Southern California chapter.
Private mortgage insurance usually is required by lenders when the borrower's down payment is less than 20 percent of the purchase price. Costs for the insurance vary, but it's usually $30 to $80 a month. You can avoid PMI by using a piggyback loan, although the interest rate on the second, smaller mortgage may be higher than the one on your first mortgage.
You may, however, be carrying so much debt that it's negatively affecting your credit score - which could increase your borrowing costs. You didn't give a breakdown of your debt, but if most of it is credit cards and car loans, rather than student loans, your score could be suffering. In that case, it makes sense to pay off the credit cards, at least, before adding to your down payment.
You can find out your credit score, and what's influencing it, by visiting www.myfico.com. For $12.95, you can view your credit report, your three-digit score and an explanation of the positive and negative factors affecting your score. You also can see, on the site's home page, how different scores alter the mortgage rates you can expect. Recently, the mortgage chart showed that someone with a score above 720 could expect a rate of 6.75 percent, while a score of 675 would move the rate up to 7.41 percent.
The site has a calculator to show how much you could save on a mortgage by boosting your credit score. You may discover the savings are so minor that you'll get more bang for your buck by saving money for the down payment, rather than using it to pay off debt. Or you may discover that a big jump in your credit score would be worth having a smaller down payment.
The site also has a simulator that allows you to "play" with your score. In other words, you can see how paying down your various debts might help your rating.
Once you've done this homework, you'd be smart to find a good mortgage broker to discuss strategy, help you crunch all the numbers and get you pre-qualified for a loan. Good luck!
Liz Pulliam Weston is a columnist for the Los Angeles Times, a Tribune Publishing newspaper.