Here’s a scenario that might surprise you: Your credit cards don’t have balances, yet your mortgage application can still be in jeopardy. Doesn’t make sense, right? Yet here’s an obstacle lenders encounter when trying to qualify you for a mortgage and you have credit card payments…
Many consumers are responsible, paying in full their monthly credit card purchases. At the beginning of the following month, they run up the card again with purchases and then pay it off again in full. Sounds like a responsible credit card habit, doesn’t it?
Well, it might not be that simple. Here’s why.
When you accumulate debt on a credit card it becomes a payment liability if the balance is not paid off in full. Creditors like major banks and credit card companies report to the credit bureaus on a certain day of the month based your payment cycle. However, even if you pay the balance in full, if the creditor reports the balance to the credit bureaus before you pay it off, the paid-in-full status won’t show on your reports for that month, the balance will. And the cycle is repeated in the following months if the cards carry a balance.
The majority of consumers do not know when each credit issuer reports to the credit reporting bureaus. Also, credit issuers may report to all three bureaus, or they may just report to one or two; it varies according to the terms of your credit card agreement.
So when you apply for a mortgage loan, the lender obtains a copy of your credit report, and debts resulting in payment obligations are listed. These debts can limit your borrowing power by subsequently raising your debt-to-income ratio (this is the total amount of mortgage payment plus payment liabilities divided into your monthly income).
Mortgage brokers, banks and lenders use the credit report they obtain to qualify you for the mortgage. If the credit report shows liabilities, they have to count liabilities even if the liabilities no longer exist because they were paid off – although after the debt was listed on the credit report.
Here’s an example: Using a credit card for various monthly purchases, you accumulate monthly debt to the tune of $5,000 that results in a $200 per month minimum payment. That $200 per month shows up on the mortgage lender’s credit report in accordance with the mortgage application, which results in $200 per month less in borrowing ability. It may not sound like much, but $200 per month can easily be equivalent to $30,000 in a financed loan amount. Well, what happens if the numbers are conservative and that $30,000 is required to approve the mortgage application?
Here’s where it gets technical: The lender and/or borrower has to reduce the debt-to-income 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: the lender obtains a new credit report at the precise timing.
Solving the Problem
If the option of borrowing less or reducing the interest rate is not an option, there are steps consumers can proactively take to omit the liabilities and help the numbers jibe.
- Call each creditor and find out when each one specifically reports to each bureau. Get the exact day of the month, or as close to it as possible.
- Have the lender qualify you while omitting the liabilities.
- Pay off the liabilities in full if you haven’t already.
- Wait for the creditor to report the new balance as a result of paying off the debt, then have the lender pull a new credit report.
The advantages to doing this include an increased credit score, as having little or no debt has a positive effect on your credit scores. It also allows the consumer to qualify for the mortgage without having to close out credit cards (which some lenders may ask you to do, depending on the circumstances). A word of caution: Closing credit card accounts can have a bad effect on your credit scores by lowering your available credit and, when the closed accounts fall off your report, can subtract from your credit history and age. (And if you want to see the impact your debt payments and other factors have on your credit scores, you can use a free tool like Credit.com’s Credit Report Card to see where you stand.)
In a refinance situation, these steps will cause the transaction to take a bit longer, but at the benefit of obtaining loan approval by virtue of less debt.
However, in a purchase situation, the results may vary because most contracts are under a certain time crunch — such as 30 days. In this case, the buyer might not have the ability to extend the contract longer and might have to close out – or pay off — the cards in full, or increase their down payment as alternative means of getting approved.
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