Can You Get a Mortgage with Credit Card Debt?
Can I get a mortgage with credit card debt?
The short answer is yes, but there are a lot of moving parts to consider. And while there’s no one-size-fits-all answer, there are some general truths that debunk the myth that homeownership is reserved only for the debt-free.
So how does credit card debt affect getting a mortgage? Here’s what you need to know.
Yes, you can get a mortgage with credit debt
The average U.S. household that carries monthly credit card balances is saddled with $8,683 in debt, according to recent data put out by MagnifyMoney, a subsidiary of LendingTree. And with 122 million Americans carrying credit card debt, it stands to reason that most homebuyers bring some level of debt to the mortgage application process — and, despite popular belief, it doesn’t automatically disqualify you from getting a mortgage.
A critical thing to remember is that your credit debt isn’t an isolated, be all, end all thing, but rather one of several key factors lenders consider when looking at a mortgage application. In addition to your employment history, down payment and loan size, two other financial details have the most swing: your credit score and your debt-to-income ratio. Your debt influences both.
Your credit score
This three-digit magic number is a reflection of what’s on your credit report and gives lenders an idea of how creditworthy you are (aka how likely you are to make good on your loan payment). A lower score makes you a riskier borrower in their eyes.
So what goes into your credit score? FICO, one of the leading credit reporting agencies, breaks it down this way:
Payment history: 35%
Amounts owed: 30%
Length of credit history: 15%
Credit mix: 10%
New credit: 10%
Your credit debt falls under the amounts owed category, which makes up nearly one-third of your credit score. Perhaps the most important detail here is something called your credit utilization ratio, which is the primary way of answering one very important question: How much of your available credit are you using? In an ideal situation, it doesn’t exceed 30%. When it tips above this point, your credit score will take a hit.
To sum things up, if two people have the same amount of credit debt and both routinely make on-time payments — but one is using up 60% of their credit lines, while the other is only using 28% — the former will have a lower score.
“Your credit score is a living, breathing, always-changing item that’s largely factored by what percentage of your available credit you’re utilizing,” Steve Bailey, vice president of underwriting at North American Savings Bank, told LendingTree.
Mortgage loans come in a number of shapes and sizes. Here are the minimum credit score requirements for each:
Conventional loan: 620
FHA loan: 500
VA loan: None (instead, lenders consider the overall loan profile)
USDA loan: 580
Your debt-to-income ratio
In addition to your credit score, your debt-to-income ratio (DTI) is the other side of the mortgage approval coin. It shows mortgage lenders, in black-and-white terms, how much of your monthly income is going toward debt payments. Why is this important? Before approving your home loan, they need reassurance that your budget can easily absorb the new mortgage payment. If existing debt is eating up a big chunk of your income, your DTI will run high, which will likely scare off lenders. The worst-case scenario is getting declined completely. Those who still get approved with a high DTI may still come up against higher rates.
Calculating your DTI is pretty straightforward: Simply tally up your monthly debt payments — which goes beyond credit debt and also includes student loans, car loans and so on — then divide the total by your gross monthly income. You can do it in a snap with this easy DTI calculator. The rule of thumb says to aim for a DTI under 36%, but some lenders may be willing to accept DTIs a bit higher than that.
The main takeaway here is that the grand total of your credit debt isn’t the most important thing — it’s how that debt relates to your income, along with your credit score, that lenders care about.
Risks of racking up credit debt while applying for mortgages
Now that we’ve unpacked exactly how lenders view your credit debt, let’s dig into some credit do’s and don’ts during the mortgage application process. According to Bailey, it’s wise to rein in your credit purchases during this time.
“Before your loan is funded, lenders are required to do what’s called a soft inquiry within a restricted time frame prior to closing to determine if any new debt has been incurred and how that impacts the final loan approval,” he said. “Typically, that will take place no more than 10 days before closing, though most lenders fall between three and five days before.”
Let’s say your credit is pulled for a mortgage preapproval before you start house hunting, and the lender is comfortable enough with your debt to write you a preapproval letter (This states your estimated loan amount and mortgage rate, which essentially backs up any offers you make). If you, say, take out a new auto loan before closing on the new house, it’s going to show up on that final soft inquiry Bailey mentioned above. New credit purchases are going to tip your DTI out of your favor, which could potentially affect your ability to qualify for a mortgage. If you’re already cutting it close with a high debt-to-income ratio, it could be what ultimately gets in the way of homeownership.
“Another thing you don’t want to do is close accounts because that can negatively affect your credit score, as well,” Bill Banfield, executive vice president of capital markets at Quicken Loans, told LendingTree. “Remember, your credit score typically affects eligibility and the price of the mortgage.”
Strategies to manage your credit debt to help you buy a house
Take a look at your credit report
The last thing you want when applying for a mortgage is to be caught off guard by credit surprises. Knowledge is power; stay in the know by checking your credit report. You can do this free of charge on sites like AnnualCreditReport.com and My LendingTree. This is where you’ll find everything from your credit history to any derogatory remarks, like late payments or delinquent accounts that have been sent to collections.
Give it a good look-over to make sure everything’s accurate. If you do come across an error, you can dispute it directly with the three credit bureaus (Equifax, TransUnion and Experian). While each issues its own credit score, the one that matters most to mortgage lenders is your FICO score, which you can figure out how to get for free here.
FYI, here’s how FICO measures your credit score:
Very good: 740-799
Poor: 579 and under
Get in the habit of making more than the minimum payment
It goes without saying that the best way to tackle credit debt, whether you’re applying for a home loan or not, is to pay down your open accounts. But if a tight budget means you have to carry balances, paying more than the minimum whenever possible is something mortgage lenders like to see.
“Fannie Mae introduced something called trended credit,” said Banfield. “Behind the scenes, when they pull credit, they’re looking to see if the customer is actually paying more and headed in a good direction, or if they’re just getting by and making the minimum payments.”
In other words, paying more than what’s required indicates to lenders that you’re serious about handling your debts responsibly.
Use a personal loan to consolidate your revolving credit debt
Remember, if your credit utilization ratio is higher than 30%, your credit score will suffer. One clever workaround is to consolidate your debt using a personal loan. Unlike credit cards, a personal loan is an installment loan, not a revolving line of credit that you can charge up and pay off as you go. Instead, it’s a lump-sum loan that comes with a fixed rate and a fixed monthly payment and repayment timeline.
If you qualify for a personal loan that has a lower interest rate than what you’re already paying across your revolving accounts, you’ll actually shell out less money in the long run. Here’s how it works: Once you receive the personal loan, turn around and pay off all your credit debts. Going forward, you’ll have one, clean payment every month, but with an added bonus — your credit utilization ratio would have plummeted (assuming you don’t charge them up again), which should give your credit score a boost.
Just be sure to do this well before the loan application process since, again, taking on new debt during this time could affect your ability to qualify for a mortgage.
What to pay off: credit debt or mortgage debt?
After getting approved for a mortgage and closing on a new home, the question then becomes, “Should I pay off my credit debt or my mortgage?”
In other words, while continuing to make the required, minimum payments across all your open accounts, which one should you hit the hardest? Bailey said it’s wise to zero in on whichever account has the highest interest rate, since that’s ultimately costing you the most money. Nine times out of 10, that’s going to be a credit card — the average interest rate these days comes in at 15.32%. Meanwhile, average mortgage interest rates range from 3.9% to 4.7%.
Prioritizing higher interest debts, also known as the avalanche method, means getting out of debt faster and paying less in interest over the long haul. You can also fold in balance transfer offers and even a home equity loan or home equity line of credit down the road to shave down your interest payments. Being a homeowner opens up the possibility of borrowing against the equity. The takeaway here is that there’s actually a number of creative ways to pay down credit card debt.
Some parting thoughts…
A huge chunk of U.S. households carry credit debt, and while that’s not necessarily something to celebrate, it doesn’t automatically disqualify you from homeownership. What really counts is how your debt is affecting your credit score and debt-to-income ratio — both of which matter greatly to mortgage lenders. Consolidating your debt with a personal loan is a viable way to boost your score. It’s also wise to familiarize yourself with your credit report and get in the habit of making more than the minimum payments when possible.
Either way, you definitely want to hold off on racking up any new debt during the mortgage application process, as this could impact your ability to get approved. Bailey has some parting words that should leave you feeling inspired.
“If you can’t get approved today, a good loan officer’s going to tell you what you need to do to set yourself up for success in the future so that you can obtain that goal of homeownership.”