When buying a home, managing your debt plays a huge role in qualifying for a mortgage. In some cases, paying off certain consumer debt, such as credit cards, at the time of closing can help you qualify for a loan by improving your debt-to-income (DTI) ratio. But is it always the right move? Let’s break down how it works, when it makes sense, and also what debts you should not pay off at closing.
How Paying Off Debt at Closing Works
Mortgage lenders use your DTI ratio (your monthly debt payments divided by your gross monthly income) to determine how much you can afford. If your DTI is too high, you might need to pay off debt before or at closing to qualify for a mortgage.
To do this, the lender may allow you to use funds from your loan, your savings, or even seller credits in certain cases to pay down specific debts. The debts you pay off are typically listed as “paid at closing” on your loan documents.
When It Makes Sense to Pay Off Debt at Closing:
- To Lower Your DTI Ratio & Qualify for a Loan
If your DTI is over the lender’s limits, paying off a credit card or personal loan at closing can help bring it down and get your loan approved. - To Improve Your Loan Terms
A lower DTI can sometimes help you qualify for better interest rates, better monthly mortgage insurance premiums, or even loan programs with better terms. - When Seller Credits Can Be Used (VA Loans Only)
A cool quirk of VA loans is that seller credits—money the seller gives toward your closing costs—can actually be used to pay off debt at closing. This can be a huge benefit for VA buyers looking to improve their DTI without dipping into their own funds.
When You Shouldn’t Pay Off Debt at Closing:
- If You Have Installment Debt with 10 or Fewer Payments Left
Mortgage lenders typically allow installment loans (like car loans or personal loans) with 10 or fewer payments remaining to be excluded from your DTI calculation. So if you only have a few payments left on a loan, paying it off at closing won’t help your DTI—meaning you could keep that cash for other expenses. - If the Debt Doesn’t Affect Your DTI
Some debts, like deferred student loans, might not factor into your DTI at all, depending on the loan program. - If You’re Trying to Pay Off a Car Lease
Paying off a lease at closing won’t remove the payment from your DTI. The balance on your credit report only reflects remaining payments—not ownership. To eliminate the payment, you’d need to buy out the lease, including the residual value. Also, leases can’t be excluded even with fewer than 10 payments left since lenders assume you’ll need another vehicle soon.
Paying off debt at closing can be a strategic move to qualify for a mortgage or improve your loan terms. But it’s not always necessary – especially if the debt is already being omitted from your DTI calculation. Before making any decisions, talk with your lender to determine the best approach for your financial situation.
If you have questions, please contact our office to discuss your mortgage needs with one of our experienced Mortgage Loan Originators at (760) 930-0569.
