Ways to Manage Credit When Seeking a Mortgage
By Scott Sheldon
Consumer debt: Many of us have it. And most who do, have a love/hate relationship with it. If you can't make the purchase with cash, do it with debt -- right? We love to know we can still consume, but we hate the bill that comes 30 days later, along with the subsequent monthly payment. Ouch!
Like it or not, your relationship with money can be best expressed on paper by how much debt you carry or don't carry, more specifically in the form of credit card debt. Credit card debt is a double-edged sword when it comes time to making high-ticket purchase like buying a home. On one end of the spectrum, having open trade lines with no debt increases a credit score, which can lower the cost of your mortgage. On the flipside, payment obligations reduce your ability to qualify, lowering how much house you're eligible for. So here's a quick guide to managing credit card debt when trying to get the holy grail (i.e. a mortgage):
How Credit Cards Help You Land a Mortgage: Credit cards that are paid current with no derogatory items or delinquencies improve and support a good credit score, which reduces your borrowing costs. Mortgage lenders typically want to see a borrower carry at least three open trade lines (and credit cards are a common form of a trade line). Examples of this would be a line limit with a department store for example or even basic Visa credit card.
Other ways credit cards help you in the mortgage process:
1. Credit cards are reported to the credit bureaus (sometimes just one or two bureaus), and are very beneficial to a credit score, assuming you have a perfect payment history.
2. Assuming you have no derogatory items or late payments, your credit card obligation can show a "pattern over time" of consistent satisfactory history.
3. If you carry no balances, this shows a lender that a person has "good character."
How Credit Cards Can Hurt Your Ability to Land a Mortgage: Credit cards, when not properly managed, have a greater effect on reducing your ability to land a mortgage than they do to improve it. Let's look at how they can do this:
1. Credit card companies are required by law to report the minimum monthly payment due, associated with any present balance carried. If the minimum payment is $100 per month, that's what will show up on the credit report, and that's the amount the lender will use, dollar for dollar. In other words, because the debt is present, how much you can borrow in terms of total house payment will be limited by $100 per month. Granted, $100 per month is small in the grand scheme of things, but the payment will reduce the amount of house payment you can take. (This goes for any minimum credit card payment.)
2. Multiple credit cards spread out with high balances and high payments limit your borrowing power because the minimum payment obligations are higher, thus reducing your potential allowed house payment.
3. Have a credit card late payment? This will tank your credit score, increasing the costs to borrow mortgage money, thereby making your home loan ... drum roll, please ... more pricey. (Note that a consistent pattern of lack of repayment over time is what really drops the credit score, which could also derail your loan approval.)
4. Credit card charge-offs still reporting a balance on your credit report will need to be zeroed out in order for you to successfully fund your new home loan. This will negatively impact your credit score. However, the negative effect of having an outstanding debt compounds due to the additional costs of paying off the previous charged-off balances, in addition to the higher interest for the mortgage from the lower credit score. Don't have the funds to pay off the previous bad debt? Then the loan won't happen.
Managing Credit Cards to Secure the Best Mortgage Terms: Because credit cards can either hinder or help your ability to get a mortgage, there is a fine line not to be crossed. The best scenario for your mortgage would be to have minimal or no credit card delinquencies of any kind in the past 12 months.
Are you paying off your credit card in full every month? Make sure you know when they report to the credit bureaus, so you can have the mortgage lender pull your credit report and credit score after that date so as to preserve high credit score. If there are multiple credit cards and you have the ability to consolidate the debt to reduce your minimum payment obligations, do it. Lenders are looking for cash flow after expenses. The more cash flow after expenses, the better your chances of a favorable credit decision with the lender.
Finally, if you know you want to buy a home in the near future, now is the time to get up to speed on your credit situation. Pull your credit reports and look for errors, signs of fraud, and areas that you need to work on (like payment history or debt usage, for example). You should also start monitoring your credit score so you can build your credit in order to get the best rates possible.
Consumers are allowed to get their credit reports for free once a year from each of the three credit reporting agencies through AnnualCreditReport.com. You can also obtain your score using free credit score tools and services. (Credit.com offers a snapshot of your scores and a breakdown of your credit profile to help you determine what areas you need to work on.) Whether you use a free score or you buy one from a credit scoring service, know that the number you see may differ somewhat from the score your mortgage lender will see, but it will nevertheless give you a helpful range to work within.
More from Credit.com:
How to Check Your Credit Before Buying a Home
The First Thing to Do Before Buying a Home
How Big of a Down Payment Do You Need to Buy a Home?
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