Homebuyers, current owners should use caution before closing credit-card accounts
Canceling a little-used credit account may seem like a good idea, but it can hurt those who hope to get a mortgage soon.
Q: We are planning to buy our first home this spring. Would we improve our credit score and qualify for a better interest rate if we cut up two or three of the credit cards we never use?
A: Think twice before hauling out the scissors. Though canceling unused cards might seem like a no-brainer, doing so can lower your credit score in the short-term, thus forcing you to settle for a higher mortgage rate when you hit the house-hunting trail. The same is true for current owners who hope to soon refinance.
Why? Because your credit score is partly based on what bankers call your credit utilization ratio — the amount of available credit that you’re using. You can calculate your current ratio by totaling all of your credit-card balances, dividing the figure by the total borrowing limits on the cards, then multiplying that figure by 100.
To illustrate, say that you have four credit cards. Each one has a credit limit of $5,000, for a combined limit of $20,000. The unpaid balance on two of them totals $4,000, but the other two have a balance of zero because you never use them anymore.
Your utilization ratio would be 20 percent ($4,000 divided by $20,000 equals .20; .20 multiplied by 100 equals 20). Most lenders offer the best rates and larger loan amounts to borrowers with a ratio of less than 30 percent, so your 20 percent ratio would help put you in a good position to obtain the best loan rate and terms.
Now, let’s instead say that you decide to close your two zero-balance cards and give up the combined $10,000 in available credit that comes with them. Cutting your borrowing power in half would double your utilization rate to 40 percent ($4,000 divided by the new, lower $10,000 limit equals .40). The higher ratio could then require that you pay a higher rate, accept a smaller loan or both.
It’s always important for potential buyers to get “pre-approved” for a mortgage so they’ll know how much they can borrow and will avoid wasting time looking at homes that they simply cannot afford. Talk to the lender or mortgage broker who will be providing the pre-approval about your plans to close some of your unused credit-card accounts.
If the lender or broker states that the cancellations won’t adversely affect your loan application, it probably would be best to first close the ones that charge an annual fee. After all, paying money each year for a card that you never use is like throwing dollar bills out of the window.
Q: I was interested in your recent statement that “improper surface grading and damage” was the most common problem found by professional home inspectors. But what are the other common defects?
A: About 36 percent of the pros surveyed by the American Society of Home Inspectors (www.ashi.com) said that bad grading — which can lead to a variety of problems, from cracked slabs to flooding in the basement, attic or crawlspace — was easily the most common problem they find when checking out a home. Twenty percent said it was faulty wiring, which is not just a cosmetic issue but also a serious safety hazard.
About 9 percent said the main culprit was old or worn roofs. That was followed by outdated or deficient heating systems, poor overall maintenance, structural problems, then plumbing issues.
Q: I like the idea of creating the type of inexpensive living trust that you sometimes recommend, because my daughter could inherit my house without wasting a lot of time and money on probate-court proceedings. But could I put my home into the trust, even though I still owe about $25,000 on it?
A: Sure. Like you, most people don’t own their homes free and clear, but there’s nothing to prevent them from transferring the property into a money-saving living trust.
By law, a simple will is required to go through formal probate proceedings to validate the document’s authenticity and allow anyone who objects to file a lawsuit. This process can take several months or even years to complete, often forcing the heir (or heirs) to spend thousands of dollars for an attorney and countless hours in court.
Conversely, a properly drawn living trust is a private document that can quickly transfer a home or other property to someone else without a court review. And because the trust document won’t go before a judge, it won’t automatically be entered into the public record. That makes it extremely difficult for nosy neighbors or sue-happy relatives to see what you left and to whom you left it.
Send questions to David Myers, P.O. Box 4405, Culver City, CA 90231-2960, and we’ll try to respond in a future column.