We’ve talked before about ways you can improve your credit score. As you and your clients likely know already, credit plays a large role in the mortgage loan process and can ultimately go a long way in the loan approval decision. When credit scores are pulled for a buyer, many believe that’s where it ends – it’s either good or not (good to go buy that new boat with a credit card!). However, that is not the case.
Once the loan process begins, any major 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 during that time, your financial situation will be under a microscope. Getting a new car loan, closing current accounts, or missing payments during that time can impact the mortgage loan process. Here are 5 credit mistakes buyers need to avoid during the mortgage loan process.
1) Maxing out credit cards.
Maxing out your credit cards is likely the quickest way to lower your credit score. If you have a credit card, it’s best to keep the balance below 30% of the total available credit. For example, if you have a credit card with an approved credit amount of $1,000, you shouldn’t have a balance more than $300. Bonus tip: if you have multiple credit cards and are considering paying down the balances, spread the payment across all of your cards instead of just one.
2) Transferring debt to 1 or 2 cards.
It’s a common practice some use 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, as more is being paid to the principal as opposed to the interest. However, on paper during a mortgage loan application, this can look like you are maxing out the card you are moving that balance to, which could potentially lower your credit score.
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 you have been approved for. For example, if you have three credit cards which have an approved credit balance of $1,000 each, your total credit available is $3,000. If you used $250 on the first card, $500 on the second, and $0 on the third, your credit utilization would be $750/$3,000, or 25%, which is below the recommended 30%. However, if you were to close the card that has a $0 balance, your ratio would instead become $750/$2,000, or 37.5%. To a lender, this could look like your debt has increased, even though all you did was close a card.
Closing a card could also impact your credit history length. That length accounts for roughly 15% of a FICO credit score. If the credit card account you closed had been in your pocket for 10 years, and your 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, do not miss a payment on existing credit lines. Payment history accounts for roughly 35% of a credit score, making it one of the most important factors in calculating a score. Even a single 30-day late payment can drop your 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 straight up. Changes such as adding new credit lines (financing a new car, getting another credit card), changing your 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 your credit report during the mortgage loan process.
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*Not intended as credit counseling, accounting or investment advice. Contact your financial representative for more information.