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Consolidate Debt Personal Loan Before Apply Mortgage?

Should you take out a personal loan to consolidate debt before you apply for a mortgage?

Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience
, Trusted Mortgage Expert with 45+ Years of Experience

Taking out a personal loan to consolidate credit card debt may improve your ability to qualify for a mortgage but there are several points to consider. The answer to your specific question depends on how the loan impacts your credit score and monthly debt payments.

In some cases your credit score dips temporarily when you apply for a personal loan. In an ideal scenario you wait several months after you apply for the personal loan before you apply for the mortgage. As long as you make your personal loan payments on-time, your score should rebound and potentially improve over time.  

Additionally, paying down or paying off credit card debt may improve your credit score which is beneficial when you apply for a mortgage. You may want to use a credit score simulator to understand how your score may change if you consolidate all or part of your debt.

Please note the interest rate on the personal loan should be less than the average interest rate on your credit cards. For example, if you have three credit cards that charge interest rates of 12%, 14% and 16%, respectively, the average interest rate on your credit card debt is 14%. In this scenario, the interest rate on the personal loan should be less than 14% and hopefully significantly lower. Consolidating credit debt with a personal loan that has a lower interest rate enables you to save money on interest expense over the course of the loan.  

Another point to keep in mind is that in an ideal scenario you payoff your credit card debt completely with the personal loan. Incurring the additional debt of a personal loan and keeping balances on multiple credit cards does not make much financial sense and may actually hurt you when you apply for a mortgage. 

If you currently have more than two credit card accounts open you may want to consider closing an account, if possible, when you consolidate the credit card debt with the personal loan.  Having three or more open credit card accounts, plus a personal loan, may have a negative impact on your credit score and your ability to qualify for a mortgage.

If you have two credit card accounts or less, we recommend that you keep the accounts open with a zero balance after you pay them off, instead of closing the accounts. Having two credit card accounts open and showing a zero balance can have a positive impact on your credit score. Having no credit card accounts open may actually have a negative effect on your credit score. We should emphasize that just because you have an open credit card account does not mean you have to use it.

We also recommend that your total loan balance not increase significantly when you consolidate debt. For example, if you are paying off $10,000 in credit card debt, get as close to a $10,000 personal loan as possible and not a higher loan amount.  You may be able to afford a higher loan amount -- and the personal loan company may push this option -- but we recommend that your loan size matches the amount of debt you have outstanding and that you do not increase your overall debt balance when you consolidate your debt.  Increasing your total outstanding debt can be a negative when you apply for a mortgage.

Another way paying down credit card debt can help you qualify for a mortgage is if it reduces your monthly debt expense. For example, replacing $500 in monthly credit card payments with a single $350 monthly personal loan payment improves your debt-to-income ratio, which is the ratio of your monthly gross income lenders permit you to spend on your mortgage and other debt payments.  This reinforces the point that the payment on the personal loan should be lower than the combined payment of the credit cards or other debt you consolidate.

The lower your monthly debt expense, the more you can afford to spend on your mortgage which enables you to qualify for a higher loan amount. So consolidating high-cost debt with a personal loan may help you get approved for the mortgage or afford more home.

You can use our mortgage qualification calculator to determine what size mortgage you can afford based on your monthly gross income and debt expenses. You can use the calculator to evaluate different scenarios depending on how much debt you plan to consolidate with the personal loan. For example you can compare the mortgage you can afford today with your current credit card payments to the loan you can afford if you eliminate or reduce your credit card payments with a personal loan.

It is important to highlight that you should never apply for a personal loan -- or any other type of loan for that matter -- in between when you apply for a mortgage and when your mortgage closes as this may cause your application to be rejected.

We always recommend that you contact multiple lenders to understand how they would handle your unique situation. You can review lenders in your area on the table below. We advise you to contact at least five lenders as as qualification guidelines vary. Plus, shopping lenders is the best way to save money on your mortgage.

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Current Mortgage Rates as of June 20, 2019
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Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. Click for more information on rates and product details.

You can also use our Personalized Mortgage Quote feature to receive no obligation mortgage quotes from leading lenders. Like everything on FREEandCLEAR, these features are free to use and help you find the mortgage that is right for you.

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About the author

Harry Jensen, Mortgage Expert

Harry is the co-founder of FREEandCLEAR. He is a mortgage expert with over 45 years of industry experience. Over his career, Harry has closed thousands of loans for satisfied borrowers and now offers his advice and insights on FREEandCLEAR. More about Harry

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