In order to make mortgage loans available to more low-income and first-time homebuyers, Fannie Mae and Freddie Mac have started backing mortgages with down payments as low as 3 percent of the home’s price. These so-called low-down mortgages have both pluses and minuses, and may or may not fit your unique situation.
On one hand, putting the customary 20 percent down enables a borrower to avoid paying mortgage insurance (PMI) and may reduce the mortgage interest rate. On the other hand, mortgage interest rates are already at historically low levels, so it might be advantageous to use down-payment cash to pay off high-interest credit cards or personal debt.
Before deciding, you should calculate how much you’d actually save by paying off higher interest debt, and the impact a higher mortgage rate and PMI would have on your monthly mortgage payments. Also consider factors such as how much debt you have, the interest rate on your existing debt, and how large a mortgage you want to qualify for.
Based on this information, your other assets, your credit history, and your down payment, the bank or broker will determine how large a mortgage they can offer you and at what rate.
Generally, it makes sense to pay down existing debt if you want to max out your mortgage loan. It’s almost always better to trade high-interest debt for low-interest debt. Moreover, you can deduct mortgage interest on your taxes and thereby further reduce the effective rate you pay on your home loan.