Should you pay off your credit card or your mortgage first? Credit cards and mortgages are two of the largest debts that most people have, and if you have the opportunity you should pay them down. However, you should carefully consider which to get rid of first. A good understanding of how loans work and a sound financial plan will help you make good decisions about your debts.

  • Bank cards carry the highest interest rates of any loans
  • Mortgages have lower rates because they are secured by the house

Usually, revolving accounts should be the first debts you eliminate, and mortgages should be the last. However, if you are applying for a loan you should talk to your banker before you eliminate any debts.

Credit Cards

Credit cards always carry a high interest rate, because they are unsecured loans. In fact, these are probably your highest interest rate loans. These are unsecured, which is riskier for the bank. In addition, there are other reasons to eliminate revolving debt as soon as possible.1

  • Paying off revolving debt improves your credit score
  • FICO scores weigh credit card debt more heavily than other types of loans
  • If you lower your credit utilization ratio (how much you owe in relation to available credit) you will improve your chances of getting better loans

Revolving debt is the worst kind that you can carry. Therefore, you should eliminate it as soon as you are able.

Pay Down or Pay Off

Whether to pay down or discharge your credit cards depends on your financial situation. Any time you can make payments to reduce your balance, do it. Pay down these balances as much as you can and eliminate them as soon as possible.

Revolving interest is so high you are probably better off taking out another loan to get rid of it. Whether this is a good idea depends on how much revolving debt you have because other loans will have closing costs.

If you have that much debt go to a financial services group that helps people control their spending or obligations before you consider restructuring your loans. A group like Crown Financial is a good place to start.

High Balance Vs. Interest

Another important question is which card to eliminate first, the one with a higher balance or the one with the higher interest. While a higher balance usually means a higher monthly payment, higher interest means you are paying more for each dollar you borrow. Therefore, it is better to pay your debts with high interest first.

If you have several loans you should consolidate them into one loan. This has a few advantages.

  • One monthly payment is easier to keep up with
  • You can probably get a lower interest rate on a consolidation loan with collateral
  • You will improve your FICO score

Finally, if you have several loans and you have trouble making payments consider financial counseling. A trained expert can help you set up a budget and get your spending under control. A good resource to start with is Dave Ramsey’s organization.

Mortgages

Mortgages are among the most secure loans available. They use your house as collateral. The downside is that if you don’t make your payments you will lose your house, but banks provide the best interest rates on these loans. In addition, mortgage interest is usually tax-deductible.

These two reasons make your mortgage one of the best loans that you can have. While it is a good idea to eliminate your loans as you are able discharge your mortgage last.2

Pay Off House

It is always a good idea to eliminate debt, but whether you should discharge your house early may or may not be a good idea. You should consider some other factors before you make this decision.

  • What other debts do you have?
  • What other investments are available?

Your mortgage should be the last loan that you eliminate. Beyond that you may have other opportunities. If you must liquidate an investment that pays a high interest rate, then it is not a good idea. On the other hand, if you have an investment opportunity with a higher interest then you should explore that avenue before deciding to settle your mortgage.

Eliminate Credit Cards Before Applying for Mortgage

Eliminating revolving accounts before you apply for a mortgage may seem like a good idea, but it may not be. Paying down balances on revolving accounts is probably a good idea, but do not cancel them right before you apply for a mortgage. Here are some things to consider about your high-interest obligations when applying for a mortgage.3

  • You will have high closing costs on a mortgage, so can you afford to discharge your revolving accounts?
  • If your revolving debt is too high, you may not be able to qualify for a mortgage, because your debt to income ratio will be lower
  • Don’t consolidate debt onto one card, because it will hurt your score
  • Don’t close any accounts, because that will reduce your credit availability and shorten your history

When you apply for a mortgage the bank will look at your total credit history. If your history is good you will get the loan, but if it is bad then you will not. Trying to clean up your history may cause more problems. Further, paying off debt may put you in a more precarious position if you don’t have enough savings for closing costs.

It is important to talk to a mortgage professional before you decide to discharge your revolving accounts ahead of your application. You may find that what seems like a good idea will cause you problems.

References

  1. Financesonline.com
  2. Investopedia.com
  3. Realtor.com