Your One Stop Resource for Saving Money.
Mortgage Comparison - The Bills.com Blog
Bills.com Blog > Mortgage Questions > Mortgage Comparison
Mortgage Comparison
Thursday, Aug 13, 2009
Question: I am interested in buying my first home within the next year. I'm wondering which will have the better effect on obtaining a better interest rate: a bigger down-payment or paying off more or all of my credit card debt. For example, which would afford a lower interest rate (given everything else the same): a 3% down payment with $5,000 in credit card debt or a 10% down payment with no credit card debt.
Answer: You are looking for a simple answer, but your question contains many variables so my answer will be a complex. First, let us look at a constant in the equation: 35%. That is the ratio that banks look for as the maximum percentage of debt a household should have as a percentage of income.Let us compare you, with zero debt, and a neighbor. Let us say your neighbor earns $500 more per month than you do, but also pays $500 each month in credit card debt. Assuming equal down-payments, the bank will see you as a more attractive risk than your neighbor. You can handle a larger mortgage than your neighbor because your debt ratio is lower. You merit a more attractive rate because you present a better risk than your neighbor, all other things being equal.
Now let us add the down-payment variable.
A 20% down payment reduces your principal as compared to a no-down or 3% down payment. It also buys you a lower interest rate, makes it easier to qualify for a loan, and removes the requirement to buy private mortgage insurance. Weigh the benefits of waiting to buy a house with a 20% down payment verses buying sooner with a smaller down payment.
Regarding your question, the difference between 3% down and $5,000 existing debt verses 10% down and no debt is huge. Again, the rule of thumb is that your debt load should be no greater than 35% of your monthly household income. For the sake of argument, let us say for the sake of argument that your household income is $4,000 per month. That means that you can afford a $1,400 debt load. If you pay $300 each month to pay down the existing debt, that means the bank will figure you can afford a $1,100 mortgage
Regarding your question, the difference between 3% down and $5,000 existing debt verses 10% down and no debt is huge. Again, the rule of thumb is that your debt load should be no greater than 35% of your monthly household income. For the sake of argument, let us say for the sake of argument that your household income is $4,000 per month. That means that you can afford a $1,400 debt load. If you pay $300 each month to pay down the existing debt, that means the bank will figure you can afford a $1,100 mortgage
payment. On the other hand, if you have zero credit card debt, the bank will figure you can afford a $1,400 monthly payment.
What is the difference between a $1,100 per month house and a $1,400 per month house? Assuming a 5.5% interest on 30-year loans and $2,000 in annual property taxes, a $1,100 payment buys a $165,000 mortgage, and $1,400 payment buys a $230,000 mortgage. Granted, the more expensive house will have higher property taxes, so this illustration is somewhat exaggerated. I am trying to make the point that driving down your other debts frees you for a larger mortgage and a pricier house in a nicer neighborhood. To compare mortgages, the Federal Reserve Board offers a nifty mortgage comparison tool.
To learn more about mortgages, read the Bills.com article about mortgage basics information.
I hope this information helps you Find. Learn & Save.
Best,
Bill
www.bills.com/blog/
What is the difference between a $1,100 per month house and a $1,400 per month house? Assuming a 5.5% interest on 30-year loans and $2,000 in annual property taxes, a $1,100 payment buys a $165,000 mortgage, and $1,400 payment buys a $230,000 mortgage. Granted, the more expensive house will have higher property taxes, so this illustration is somewhat exaggerated. I am trying to make the point that driving down your other debts frees you for a larger mortgage and a pricier house in a nicer neighborhood. To compare mortgages, the Federal Reserve Board offers a nifty mortgage comparison tool.
To learn more about mortgages, read the Bills.com article about mortgage basics information.
I hope this information helps you Find. Learn & Save.
Best,
Bill
www.bills.com/blog/
Also, make sure to get a free financial health check-up with Bills IQ!
Submit questions/comments about this post:
Bill has answered all sorts of questions and has been able to provide those in need of financial guidance with helpful and valuable advice and information on their specific financial area of interest. If you need specific guidance on any of the above mentioned financial areas, feel free to Ask Bill your financial questions and get better informed. Also, make sure to get a free financial health check-up with Bills IQ!
Information provided by Bills.com is for general informational purposes only and is not be
construed as legal, financial, bankruptcy, tax or other professional advice. Should you
require more detailed information or specific professional advice tailored to your situation you
should consult an attorney, financial planner or tax advisor.
While we believe all information provided by Bills.com to be accurate as of the date of its posting, we cannot ensure its accuracy. Use of this site and any information contained on or provided through this site is provided without any representations, warranties or guarantees. Bills.com is not responsible or liable for any decisions or actions anyone may take based on the information provided. Please see Terms of Use.
While we believe all information provided by Bills.com to be accurate as of the date of its posting, we cannot ensure its accuracy. Use of this site and any information contained on or provided through this site is provided without any representations, warranties or guarantees. Bills.com is not responsible or liable for any decisions or actions anyone may take based on the information provided. Please see Terms of Use.
© 2006 - 2009Bills.com LLC. All Rights Reserved.