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Understanding how your credit card usage affects your credit score

April 8th, 2015 6:58 AM by Susan C Pearlstein

If you are considering purchasing real estate or refinancing there are important steps that you can take to prepare ensure you are able to obtain the best rate possible.

How the mortgage process works

To decide what to do with your credit cards before you apply for a mortgage, it helps to understand the process of securing a home loan, which is different from any other loan you’ll apply for.

There are three factors lenders will consider about your personal finances when determining your qualifications: your down payment, your monthly income (minus any existing debts), and your credit score. The second and third factors are the ones that can be impacted by your credit card usage.

When you first speak with a mortgage broker, you’ll give him or her permission to pull your credit histories and FICO credit scores from all three major consumer credit bureaus. While these inquiries count as a “hard pull,” the FICO scoring model doesn’t count additional inquiries for home loans made within 14 days. Brokers pull from all three bureaus because the industry standard is to judge applicants based on the middle of the three scores (or the lower of two), in order to account for any differences in the data collected.

Next, your real estate agent might ask for a pre-qualification or a pre-approval from your mortgage broker. A pre-qualification is merely the broker’s opinion of your ability to qualify based on the information that you have supplied, while a pre-approval generally requires documents to be collected such as pay stubs, bank statements, and tax returns. This additional level of verification can add substantial weight to a home contract that a pre-qualification does not.

Your mortgage broker will then help select the best lender for your needs, and you’ll be asked to submit a formal loan application. Finally, about a week before you close on your loan, your credit will be checked a final time (which is a soft pull), and your employment will be re-verified.

Credit cards can help your credit score by adding to your overall credit history, so long as you pay your bills on time and carry little debt. Your payment history and the amounts you owe comprise 35% and 30% of your credit score, respectively, making them by far the two most important factors. In addition, 15% of your score is focused on the length of your credit history, so keeping a few credit card accounts open for many years will help.

The remaining 20% is divided equally among the types of credit used and the new credit lines opened. Having credit card accounts open and in good standing will help, although applying for several new credit cards in a short period of time will hurt. 

One of the big misconceptions about credit scores is that having a higher score will necessarily lead to lower rates. To qualify for the best mortgage rates available, you need to have a credit score of 740 and above, but in nearly all cases, having a score of 760, 780, 800, or higher won’t make the slightest difference. (Scott pointed out that he has seen some rare exceptions in the past when a lender offered a specific program that required higher scores, typically for very high value loans).

Let’s say that you pay all of your bills on time and have no substantial debts other than a modest credit card statement balance, which you pay in full each month. The chances are that you’ll have a credit score in the high 700s. If you decide to apply for a new credit card, your score may drop a few points, but so long as it remains comfortably above 740, you won’t hurt your chances to qualify for the best mortgage rate

Once you have received a pre-approval from a mortgage broker or the lender the following are steps to ensure that your credit does not drop during the mortgage process.

  • Do not use credit cards excessively.
  • Do not let current accounts fall behind.
  • Do not co-sign for anyone on a new account or loan.
  • Do not give permission to anyone to run your credit (by applying for new credit accounts).

If you can avoid creating any new significant debt during the loan process you should not have any last minute surprises.  This is not the time to buy a new car, furniture or to make any large purchases.

Posted by Susan C Pearlstein on April 8th, 2015 6:58 AM

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