What First Time Home Buyers Need to Know About Their Credit Card Balances

Many people who feel they are prepared to enter the real estate market by purchasing their first home have experienced a roadblock to good mortgage rates – their credit cards. Credit cards can play a positive, but also a negative role in the process of purchasing a home.

There is not a doubt that having a credit card can work highly in your favor when it comes time to shop around for your first home.  If you have a consistent history of timely credit card payments this builds a strong credit rating.  Having a high credit score not only will secure you a mortgage quickly, but one with very competitive rates.

Your credit card can be very influential when determining what mortgage you are seeking because the credit card payments are added to what the payments ‘would be’ on a possible mortgage to determine how much can be afforded.

Purchasing a house requires you to have a certain percentage of cash for the down payment and affiliated costs (such as legal fees). Generally speaking, the more cash you can put toward the down payment the lower the mortgage cost.

buying a houseFor those who may not be in such a desirable position, they need to examine their loan-to-debt ratio.  First, take a look at your monthly gross income.  Lenders use terminology including front-end ratios.  What this means is that a front-end ratio is the payment a purchaser can afford from the lender’s perspective, regardless of what you may want to pay monthly.  The back-end ratio reflects the mortgage payment plus all debt.

If your credit card carries a high balance or if there have been some recent struggles paying the credit card monthly payment by the due date, this may not be such a good time to consider shopping for your first home.  This will reflect on the lender’s outlook at your ability to be financially responsible in paying a mortgage.  There are inevitably some high-risk lenders who exist and are willing to take a chance on what is considered a risky mortgage loan, but the interest rates will reflect this by being much higher; therefore the monthly payment may be more than what is realistically affordable.

Some first-time home buyers ask if they can have their credit card debt added to the mortgage they are seeking so that it eliminates this debt.  The answer is no.  When you buy a house, the mortgage is secured by ‘collateral’ and that is the house.  A lender will not provide a loan for anything other than the collateral.

Some people have made a serious mistake by taking cash advances from their credit cards to use as a down payment. This cannot be stressed enough – not only can this become a financial disaster to the individual, it is breaking the rules.  Those who are determined to break these rules have taken out cash advances well in advance of buying their first home and have put this money into a savings account.  The only way this can work is if the cash advance is taken out more than two months before applying for a mortgage and have that cash sit in the bank.  The money then avoids questioning from the lender because any length of time shorter than that means you will have to come up with the required documentation to validate the source of the money.

While there are ways around the rules, it is really important to understand why these rules exist – they are designed to prevent people from doing this because it ultimately ends up becoming a serious financial nightmare.

Bottom line; keep your credit cards in good shape by maintaining a consistent history of timely credit card payments and a low balance.  The reward in doing so will help the first time home buyer in obtaining the best-available mortgage.

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Published or updated May 10, 2013.

Comments

  1. Thanks, Glen. It seems that credit card debt is so common that people forget that it will affect other choices they make.

    But I’d also add that you don’t need credit cards to get a mortgage. Many mortgages can accept “nontraditional credit.” So if you can prove you’re paying rent, utilities, and other bills on time, you may very well be able to get a mortgage without ever getting a credit card. And for some folks, this might be their very best way of avoiding future trouble.

    • Avoiding credit cards is indeed one way of keeping yourself out of debt problems.

      But the reality is, a credit score is hugely impacted by your credit card use. If you can prove that you use a credit card responsibly then that will have a positive impact on your credit score and can yield you a lower mortgage interest rate (or even get you to qualify in the first place in some cases).

  2. Good tips Glen! I would also add, don’t go over 30% of your limit. If you do, pay it off immediately before your lender does a credit pull.

    • It’s important to understand the spending limit on your cards and make sure your debt is a low percentage (or ideally zero – or rather you pay off your balance monthly).

  3. I love credit card talk. I am actually surpried so many people try going for a mortgage with a poor credit rating.

    • I wouldn’t be surprised if many people start the process of looking for a home without even knowing what their credit report and credit score look like.

  4. You also need to make sure that you are paying your balance before the closing date. The closing date balance it what shows up on your credit report. If you pay in full each month, it doesn’t matter because your balance on your credit report will still be the closing date amount. Pay your full balance several days before your closing date, and it will show up as $0 on your report, which will look great!

  5. No Debt MBA says:

    My SO and I definitely took extra care to manage our credit card balances before applying for a mortgage. I can’t believe that some people take cash advances for their down payment! You’d think a 0-down mortgage at least would be cheaper but maybe they couldn’t get approved?

    Of course all your advice also applies to applying for car loans, student loans, etc. Anything where they’re pulling your credit report and want to make sure you don’t have too much debt.

    • I think you always want your credit score to be the best it can. You just don’t know when it might be pulled. But with a mortgage you may have tens of thousands at stake if your credit score is incorrect or not as good as you think it is.

  6. It all boils down to making responsible and informed financial decisions… If an individual is struggling to manage credit card debt, then this person shouldn’t be in the market for a house right now.

    Buying property is one of the biggest financial transactions most people will encounter in their lives. But sadly, many people don’t approach it that way.

    • It’s a purchase that can very well put you in debt for 30 years, where you will end up paying 2x what you borrowed.

      Remember though, just because a person has credit card debt it doesn’t mean they are struggling to make payments.

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