One of the most important things you can do before applying for a mortgage is pay your bills on time to boost your credit score.
Gearing up to apply for your first mortgage is equal parts exciting and terrifying. To calm your (understandable) jitters, you’ve probably done a lot of reading about interest rates, points, homeowners association fees and the like. After all, knowledge is power.
Unfortunately, many first-time homebuyers fail to consider the impact their credit card habits could have on their ability to get a mortgage. This sometimes leads to a nasty surprise when it comes time to finalize the loan documents.
The good news is that this doesn’t have to happen to you. Here are five credit card mistakes that could prevent from getting a mortgage – and how to avoid them.
1. Paying late.
One of the critical factors bankers and mortgage brokers look at when deciding the terms of your home loan is your credit score. Most lenders use the FICO score to assess your creditworthiness, 35 percent of which is determined by your history with paying your bills on time.
You probably see where this is going: If you habitually pay your credit card bill late (or any other bill for that matter) your credit score might be in shoddy shape. You’ll need to seriously tighten up your on-time payment record if you want to qualify for a mortgage.
Luckily, technology can help make this happen. For most folks, the easiest way to ensure that payments are made on time is to set up automatic payments for bills. You can also opt into account alerts so that you’ll get an email or text message when a payment is due.
Whichever strategy works for you is fine, as long as paying on time is a top priority.
2. Overutilizing credit.
Speaking of your FICO score, there’s another credit card-related factor you should be aware of before submitting your mortgage application: 30 percent of your score is determined by the amounts you owe on your credit accounts. This category is heavily influenced by your credit utilization ratio, which is the credit you have used compared with your credit limit. Usually, it’s expressed as a percentage.
Using more than 30 percent of your available credit on any of your cards at any point during the month can cause your credit score to drop. Again, the point here is probably obvious – if you typically carry a high balance on your cards throughout the month, now is the time to monitor them carefully and make sure you’re not exceeding that 30 percent threshold. If you start to get close to it, make a payment as soon as you can.
This might seem like a small move, but it could go far in improving your score at the moment you need it to be as high as possible.
3. Applying for too many cards at once.
Another big misstep that would-be homeowners make when they start getting serious about mortgage applications is simultaneously signing up for a bunch of new credit cards. Many folks reason that they’ll need the credit for moving expenses, but this is a bad move for your FICO score. Ten percent of it is determined by new credit inquiries, which are triggered when you apply for loans and credit cards. Adding several to your credit report as you’re trying to finalize the terms of your mortgage could be very damaging.
What’s more, applying for a bunch of credit cards at once is often interpreted as a signal that you’re in financial trouble. Even if your score stays solid, your mortgage lender might think twice about extending a big loan to someone who could be experiencing a cash-flow crisis. To be on the safe side, place a moratorium on credit card applications until after you’ve moved into your new home.
4. Never getting a credit card at all.
This one might seem strange, given all the dangers associated with overusing credit cards, but responsible swiping is critical in establishing a good credit profile. In fact, 15 percent of your FICO score is determined by the length of your credit history.
Aside from this, bankers like to see a credit history that’s long and strong before they lend you hundreds of thousands of dollars. If you’ve only had limited interactions with credit in the past, getting a home loan might be tough.
Since you can’t go back in time and apply for a credit card as a young adult, getting started today is your best option. If your credit history is truly nil, you might have to postpone homeownership for a year or so. But getting a card now and using it consistently and responsibly during that time will go far in helping show that you’re a reliable borrower.
5. Racking up debt.
You probably already know that credit card debt is expensive and potentially damaging to your credit. But did you know it could also be a significant obstacle to getting a mortgage?
Here’s why: Aside from your FICO score, a number that heavily influences lending decisions is your debt-to-income ratio. To calculate your DTI, you’ll need to add up all your monthly credit payments (along with certain other obligations) and divide this figure by your gross monthly income. Although standards vary from bank to bank, most like to see a DTI of 36 percent or less. If you’re carrying a ton of credit card debt, your DTI might be too high to get a home loan.
The smartest thing you can do in this scenario is pay off as much of your credit card debt as quickly as you can. This will improve both your DTI and your credit utilization ratio simultaneously, making you a much more attractive candidate for a home loan.
Be sure to keep these credit card pitfalls and tips in mind as you take steps toward realizing the American dream – happy house hunting!