Credit Card Debt Can Kill Your Mortgage Options
Did you know that carrying too much credit card debt can hurt your chances of getting a mortgage loan? It’s true. But it comes as a surprise to a lot of first-time home buyers. I know, because I get a lot of their emails. They say things like this: “I knew my credit card debt was a problem for other reasons, but I never thought it would lead to my mortgage application being denied.”
Many people learn this lesson, but they learn it too late. So I’m writing this article to teach you this important lesson now. If you understand the connection between credit card debt and mortgage approval, you’ll be in a much better position when it comes time to apply for a loan.
Problems Associated With Excessive Credit Card Debt
There’s nothing with carrying a small and manageable amount of credit card debt, and it’s something that millions of Americans share in common. But when you have a lot of debt, you can hurt your chances of getting approved for a mortgage loan.
There are two primary reasons for this, and they are both referred to as “ratios”…
- A high credit-utilization ratio will lower your credit score, which makes it harder to get a loan.
- When you carry too much debt relative to your income, you show that you can’t manage your finances properly. This is your debt-to-income ratio, or DTI, and it can raise a red flag with mortgage lenders.
Now let’s talk about each one of these problems in turn:
Credit Utilization Ratio
Your credit-utilization ratio is part of the formula that determines your credit score. This ratio is a comparison between the amount of credit you have available and the amount you are actually using. For example, if you have a credit card with a $5,000 limit, and your balance is $4,400, then you have a very high utilization ratio. This also shows that you rely too heavily on your credit cards.
You can see from the chart below that the amount you owe on your credit accounts (your utilization ratio) accounts for 30% of your FICO credit score. FICO is the one used by most mortgage lenders, by the way. So if you’re carrying too much debt in this department, it can really drag your score down.
Here’s the bottom line on utilization. Carrying too much credit card debt can hurt your credit score, which lowers your chances of being approved for a mortgage loan.
Debt to Income Ratio
This is similar to the ratio we talked about above, but it compares your overall debt to your income level. This is something mortgage lenders use judge your financial stability. If you have a lot of debt already, relative to your income, you’ll probably have a hard time getting approved for a loan.
A high percentage of people in this situation end up in foreclosure later on. Lenders know this, so they are reluctant to give mortgages to people who are carrying too much debt (whether its from credit cards or anything else).
Getting Help with Credit Card Debt
There are plenty of companies out there that would gladly take your money, in exchange for credit help services. But most of them are scams. They require upfront payments from their customers, and then they fail to deliver on their bold promises. Do a search for credit card help on the FTC’s website, and you’ll see what I mean.
But there are also a handful of legitimate non-profit organizations that can help with credit card debt reduction. They obviously won’t pay your bills for you — that’s your responsibility. But they can help you set up a budget, a payment plan and more. Here are two worth considering:
In addition to the organizations above, you might want to consider talking to a HUD-approved housing counselor. They can give you advice on home buying, credit issues and more. You can find a counselor in your area by visiting the HUD website.
Whatever you do, steer clear of the so-called debt relief companies with the bold promises … they just want your money. Stick to the non-profit organizations I’ve listed above.
Conclusion
Using a credit card can actually help you improve your credit score, which makes it easier to get a mortgage loan. This might sound like a paradox, but it’s not. It all comes down to how you use the credit you are given. Consider the following two scenarios:
If you make occasional purchases with your card and pay the balance down each month, this creates a pattern of responsible usage. It shows lenders that you know how to use credit wisely, which is exactly what they want to see. Here’s what is says about this on the FICO website (the people who developed the most popular credit-scoring model):
Someone with no credit cards, for example, tends to be higher risk than someone who has managed credit cards responsibly.
The key word in this quote is “responsibly.” By keeping your balance low (relative to your credit limit), you can create a long pattern of responsible usage. This will boost your score and make it easier to get mortgage loans and other financing.
On the other hand, if you rack up a lot of credit card debt, you are creating a pattern of over-reliance and irresponsible usage. This lowers your credit score. You are also increasing your total debt, relative to your income. Both of these things will make it harder to get a mortgage loan — especially in the post-recession economy where we find ourselves.
I hope this article helps you understand the connection between credit card debt and mortgage loans. Good luck.
Mortgage Loans | Brandon | 
September 29, 2009 7:49 am