A person’s credit score is essential when it comes to being approved for any kind of loan – personal loan, auto loan, home loan, or even a credit card. The higher the number, the more creditworthy your clients are.
As a real estate agent, you already understand that credit plays a significant role in the mortgage loan process and can ultimately go a long way in determining if your client is approved for a mortgage loan.
When credit scores are pulled for a buyer, many believe that’s where it ends – it’s either good or not. However, that is not the case.
Once the loan process begins, any significant financial changes can trigger red flags – at any point in the loan process. The average length of time it takes to get a loan is around 30 days, which means that your client’s financial situation will be under a microscope during that time.
Getting a new car loan, closing current accounts, or missing payments during that time can impact the mortgage loan process.
5 Credit Mistakes to Avoid Between Application and Approval
Here are five credit mistakes your clients need to avoid during the mortgage loan process.
1. Maxing out credit cards
Maxing out credit cards is likely the quickest way to lower a credit score. If your client has a credit card, they should keep the balance below 30% of the total available credit.
For example, if they have a credit card with an approved credit amount of $1,000, they shouldn’t have a balance of more than $300.
Bonus tip: if they have multiple credit cards and are considering paying down the balances, they should spread the payment across all the cards instead of just one.
2. Transferring card debt to 1 or 2 cards
It’s common to transfer a balance on a high-interest credit card to one with a lower interest rate. With a lower interest rate, balances can be paid down more quickly because more is paid to the principal instead of the interest.
However, on paper, during a mortgage loan application, this can look like your client is maxing out the card they are moving that balance to. This could potentially lower your client’s credit score, so warn them against using this approach.
3. Closing credit card accounts
When it comes to a lending decision, one factor that is looked at is an applicant’s credit utilization ratio. This is essentially the percentage of credit being used out of the total credit amount approved for.
For example, if they have three credit cards with an approved credit balance of $1,000 each, their total credit available is $3,000. If the borrower used $250 on the first card, $500 on the second, and $0 on the third, their credit utilization would be $750/$3,000, or 25%, which is below the recommended 30%.
However, if your client were to close the card with a $0 balance, their ratio would instead become $750/$2,000, or 37.5%. This could look like the debt has increased to a lender, even though all they did was close a card.
Closing a card could also impact their credit history length. That length accounts for roughly 15% of a FICO credit score. If the credit card account they closed had been in their pocket for 10 years, and their newer accounts less than five, that is a drastic change in credit history length on paper.
4. Falling behind on existing accounts
This likely goes without saying, but especially during the approval process, your clients should not miss a payment on existing credit lines. Payment history accounts for roughly 35% of a credit score, making it one of the most critical factors in calculating a score. Even a single 30-day late payment can drop the credit score between 30-80 points.
5. Doing anything that will raise a red flag
Any activity that involves significant financial changes during the mortgage loan process can cause a lender’s ears to perk up. Changes such as adding new credit lines (financing a new car, getting another credit card), changing name or address with the credit bureaus, or co-signing on another loan during this time are all not recommended.
It is best to have little to no activity on the credit report during the mortgage loan process.
Help your clients out. Share these credit mistakes with them, so they are in the best possible position to be improved for a mortgage loan.
*Not intended as credit counseling, accounting or investment advice. Contact your financial representative for more information.