|Paying off credit cards can damage your loan approval
You heard it correctly. Your credit card doesn’t have balances, yet your mortgage application can still be in jeopardy.
Here’s what mortgage lenders and brokers run into when you have credit card payments –many consumers are responsible; they use their credit card for various monthly purchases and then pay each credit card off in full at month’s end. At the beginning of the following month, they rack up debt on the card again and the cycle continues. Sounds financially responsible, right?
Well not quite, and here’s why:
When you accumulate debt on a credit card, it becomes a payment liability if it’s not paid off entirely. Creditors, like major banks and credit card companies, report on a certain day of the month to each credit bureau. They may report to all three bureaus or they may just report to one or two. It varies, depending on the terms of your card agreement.
The majority of consumers when they go to apply for a mortgage loan, do not know when each creditor reports to the credit reporting bureaus. In fact, most don’t. As a result, when you apply for a mortgage loan, lender obtains a copy of your credit report, and debts resulting payment liabilities are identified limiting your ability to borrow by raising your debt ratio. (Debt ratio is mortgage payment plus payment liabilities on your credit report divided into your monthly income).
Mortgage brokers, banks and lenders use the credit report they obtain in approving you for a mortgage loan. If the credit report shows liabilities, mortgage lender must count liabilities against your income, even if the liabilities don’t exist, because they been previously paid off prior to the creditor reporting the new balances to the bureaus.
Consumer accumulates $5,000 on a single card in any given month, wherein if not paid off in full would result in a payment liability of approximately $200 per month. That $200 per month shows up on the mortgage lender’s credit report in accordance with the mortgage application this consumer applied for, resulting in $200 per month less in borrowing ability.
Doesn’t sound like a lot, but in the grand scheme of things, $200 per month can be equivalent to $30,000 in loan amount. Well, what happens if the numbers in determining whether or not the loan can be approved are close and the additional wiggle room is needed for a sign off?
Loan lender and/or borrower has to reduce the debt ratio by either borrowing less or purchasing a lower interest rate via more loan fees in the form of discount points. The other tangible solution involves lender obtaining a new credit report on behalf of the consumer with precision timing.
If the option of qualifying for a lower loan amount or reducing the interest rate is not in the cards, there are series of key steps consumers can take to make sure the liabilities are updated correctly.
1. Call each creditor (credit card lender) find out what day of the month they report to the credit bureaus
2. Have the lender omit the liabilities for conditional loan approval.
3. Payoff the liabilities in full if not completed already.
4. Wait for the creditor to report updated zero balances.
5. Lender obtains a new credit report.
An advantage to updating the credit report includes a potential increased credit score as having little or no debt looks favorably to the credit bureaus. This action also allows the consumer to attain an approval easier without having to close out the credit card.
In other words, the solution is closing the cards closed out in full via the loan process, thereby paying off the debt to qualify. In a refinance situation, these steps will cause the transaction to take a longer, but at the benefit of keeping the loan approval intact. In a purchase situation numbers become a little different because most contracts are under a certain time crunch such as 30 days for example. In a home-buying situation, the buyer might not have the ability to extend the contract longer and may have to close out the cards in full or increase their down payment as an alternative option.
Scott Sheldon is a local mortgage lender, with over six years of experience helping people purchase and refinance primary residences, second homes and investment properties. Visit him at www.sonomacountymortgages.com.