Many Americans, including myself, carry a small and manageable amount of credit card debt. There is nothing wrong with this. It is when you have an excessive level of debt in relation to your monthly income, that you can hurt your chances of getting approved for a mortgage loan.
Mortgage lenders use credit scores and debt-to-income (DTI) ratios to measure the potential risk a borrower carries. A borrower with a relatively low score and a high amount of recurring debt represents a bigger risk to the lender. This is exactly what can happen when you have a lot of credit card debt. It can lower your FICO score and increase your DTI ratio, thereby reducing your chances of getting approved for a loan. This “double whammy” is one of the most common causes of mortgage rejection these days.
Another thing to consider is your Credit-Utilization Ratio. There is a direct connection between credit scores and mortgage loan approval. Here’s a quick overview of how these two things are related:
When you apply for a home loan, the lender will review every aspect of your financial background. Your FICO credit score is a big part of this review process. If you have a high score, you’ll be more likely to get approved for the loan. You’ll also qualify for a better interest rate, which could save you a lot of money.
But if your score is too low, you might get turned down altogether. Or, if you do get approved, it might be at a rate that ultimately makes the loan less affordable in the long run.
Your score is basically a statistical indicator of risk. The lower the number, the more risk you bring to the table (from the lender’s perspective anyway). And vice versa. This is why it’s so important to review your credit report before you start shopping for a loan or trying to buy a house.
A large factor that influences your score is your “credit-utilization ratio”. If your card balances are extremely high in relation to your card limits, it will lead to a reduction in your overall FICO credit score.
The utilization ratio is part of the formula that determines your FICO score. This ratio is a comparison between the amount of credit you have available to you (your limit) and the amount you are actually using (your balance). For example, if you have a card with an $8,500 limit, and your balance is $7,900, then you have a very high utilization ratio. You are nearly “maxed out”, as you are using most of your limit. From this information, lenders typically take away that you are too dependent on your credit cards, which is clearly not helpful in receiving loan approval.
This is one of the ways in which credit card debt can affect you during the mortgage process. If you have too much of it, it could raise a red flag within the FICO scoring system. It can reduce your score and make it harder for you to obtain a home loan. So check your credit score now to see where you stand. If it’s lower than average, start an “investigation” to determine the possible cause. If you have a high utilization ratio, you may have found the problem — or at least one of the problems.