Credit cards can make or break a mortgage application
It takes a lot of planning to apply for your first home loan and getting a mortgage. You’ve demonstrated you can hold down a steady job, accumulated a healthy down payment, selected a property you can afford to own and maintain — and still you were turned down.
The problem may be with your credit cards, says Chantel Chapman, financial fitness coach at financial technology company Mogo. And the problem may be subtler than you think.
Chapman spent more than 10 years as a licensed mortgage broker, so she’s looked at mortgage applications from both sides of the fence.
“I’ve worked with a lot of first- time homebuyers,” she says. “Many of them watched the financial downturn of 2008 and have avoided credit cards completely because they don’t want to be caught in debt.”
However, mortgage lenders want to see at least a two– year history on active credit vehicles, including credit cards, personal loans, a student l oan, or even certain car leases.
“While two years is the minimum credit period they want to see, the longer you maintain that credit responsibly, the more confident the mortgage lender will be,” says Chapman.
If an applicant wants to use credit cards to establish a credit history, maintaining cards with low credit limits of a few hundred dollars each probably won’t suffice as examples of excellent credit management.
“You need to demonstrate that you can be responsible with a higher limit,” says Chapman. “You’d be much better off with two credit cards with minimum limits of $ 2,000 each. That would indicate that you could be responsible for larger amounts such as a mortgage loan.”
Will maintaining even more than two credit vehicles help to convince lenders you can really manage credit? Guess again, says Chapman. Before you can be approved for a mortgage, lenders look at an applicant’s total debt service ratio. That’s a figure calculated by adding the total of all anticipated housing expenses (including mortgage), credit card interest payments, car payments and other loan expenses, and dividing it by annual income.
“A few years ago some mortgage lenders were calculating debt service ratio by not only using your credit card balance, but also your available credit limit,” says Chapman. “If revolving credit products, such as credit cards or lines of credit, form a lot of your debt, you may have to retire some of those cards to lower your debt service ratio well in advance of shopping for a mortgage.”
YOU’D BE MUCH BETTER OFF WITH TWO CREDIT CARDS WITH MINIMUM LIMITS OF $2,000 EACH. THAT WOULD INDICATE THAT YOU COULD BE RESPONSIBLE FOR LARGER AMOUNTS SUCH AS A MORTGAGE LOAN
Homebuyers can pay off both credit card principal and interest on a realistic schedule by obtaining a personal loan, such as a MogoLiquid loan. By paying down debt, cardholders can also free up cash for a larger mortgage.
“But never shut down your oldest credit cards,” says Chapman. “Those cards probably carry your longest credit history and represent your best credit credentials to home lenders. Eliminate your newest cards first, and pay down your remaining cards to realistic levels.”
Once cardholders take control of their credit, they may be tempted to stop using credit cards altogether. That’s actually counterproductive, because credit history is based on active credit. Unused cards can drive a hole through a cardholder’s credit history.
“Use the card to pay your Netflix or some other recurring bill,” says Chapman. “Then set an automatic bank payment to pay your credit card bill and maintain an active credit history. If you’re tempted to use it for more than that, put it in a Ziploc bag full of water and stick it in the freezer to put yourself on a strict credit diet. You can move it to the freezer in your new house after the deal closes.”