Your ability to purchase a home with a mortgage depends on how much net income you have after all monthly debts. If your debt payments absorb your income, particularly credit card payments, you may have to put the brakes on the mortgage application.
Most homebuyers realize that in order to purchase a home they need at least good credit, and that a better credit score means a better chance of qualifying. One of the ways to build and maintain a healthy credit score is the ability to use and manage credit over a period of time. Using three to five credit cards actively, paying them off in full each month is a fantastic way to support a good credit score, a benchmark factor in qualifying for the prize. However, credit cards are not something to be taken lightly, and you should exercise caution with them, especially if they are not paid off in full every month.
When it comes to qualifying for a mortgage, it’s not what you owe in total that counts, it’s what you pay each month. Most lenders allow a maximum debt-to-income ratio of approximately 45 percent, meaning they allow up to 45 percent of your monthly pretax income for a proposed new mortgage
When it comes to getting a mortgage, the key with carrying a balance on any one credit card is the monthly payment.
payment and any other debts. Let’s take a look at the various credit card scenarios and what you can do to help your chances of qualifying for a mortgage.
1. Spreading Out Your Debt: When it comes to getting a mortgage, the key with carrying a balance on any one credit card is the monthly payment. In most circumstances, the larger the balance on any one credit card, the larger the monthly payment. The higher the monthly payment on any individual card, the more likely you will not be able to purchase as much house. (You can see how much house you can afford here.) Let’s say you owe $10,000 on a credit card and the monthly payment associated with the obligation is $200 per month. To maintain your ability to qualify, a lender would require $400 per month of additional income to offset that debt.
However, if this balance could be spread out over, say, two or three credit cards with lower interest rates that would result in lower payments totaling less than $200 per month, you come out ahead.
2. Credit Card Payoff: If you’re looking to attack your credit card debt and pay it down (you can use the credit card payoff calculator to see how long it will take you) in preparation for qualifying for a mortgage, you might wonder which of your cards you should target.
If you’re trying to buy a home, paying off the higher-rate credit cards first might be a good move if the monthly payment is higher than the cards you have that are 0 percent. In other words, for buying a house, you’ll want to pay down the cards that have the highest monthly payment regardless of the interest rate, because those are the ones that will affect your qualifying ability the most.
So which card should you focus on paying down? Let’s say you have a 0 percent interest credit card with a $2,000 balance and a $150 monthly payment. You also have a 6 percent interest credit card with a $5,000 balance and a $50 monthly payment. You’ll get a bigger bang for your buck paying off the credit card with the higher payment despite the fact that it’s 0 percent. The idea here is that you’ll want to cherry-pick the cards with the higher monthly payment in order of priority to maximize your buying potential. A good mortgage lender can assist you tremendously with this task.
*As a good rule of thumb for financial planning, it does make sense to tackle the higher interest rate credit cards first because of the additional interest expense you’ll pay over time, but that is not necessarily the case when it comes time to qualify for a mortgage.
3. Consolidating Your Cards: Let’s face it, people carry credit card debt because they don’t have the cash to make the purchase outright. Consolidating any 0 percent interest credit cards or even other credit cards into one credit account containing a total new lower payment can help you qualify to buy a home. Why? It has to do specifically with the minimum monthly payment. Even if you choose to make a pre-payment each month in an effort to accelerate the debt payoff, it’s about the minimum obligation per credit card the lender will use in determining whether or not you’ll be able to buy that house, so consolidating may help.
If you have the cash, or are trying to decide whether to use the cash for the down payment or paying off debt, talk to a lender. If you do plan to pay off the credit cards to qualify, this can be accomplished as a special lender exception (not all lenders allow paying off debt to qualify). For example, if you’re in contract to buy a home and your loan gets rejected by the underwriter because your debt-to-income ratio is too high, one way to reduce the ratio to get your loan approved is to pay off your credit card balances in full. This route entails one additional step in order to remove the obligation: You would have to pay off the credit card in full and close the credit account.
In most cases, closing credit card accounts can adversely affect your credit score. However, a new mortgage loan in your name, paid on time every month, can also be instrumental in building a good credit rating.
You can find out how your debts affect your credit scores by checking them for free on Credit.com.
Scott Sheldon is a senior loan officer and consumer advocate based in Santa Rosa, Cali. His work has appeared in Yahoo! Homes, CNN Money, MarketWatch and The Wall Street Journal. Connect with him at Sonoma County Mortgages.