How your credit cards could impact your home loan

While it's true that having a credit card can help build your credit score, it can also work against you when it's time to apply for a home loan.

How does your credit card affect your credit score?

Just as employers might use your university GPA to gauge your likely performance at work, lenders use your credit score to help determine whether you'll be able to repay a loan.

If you're looking to borrow, lenders will consider your credit score as an indicator of risk - the lower your credit score is, the riskier you appear.

But it's how you use your credit card that impacts your overall credit score. If you have a credit card and pay your bills on time - or, ideally, clear your debt completely each month - it's considered a good indicator you'll be similarly diligent in making home loan repayments.

However, if you don't pay your bills on time or routinely miss payments, your credit score will likely have suffered.

Even a single instance of a missed credit card repayment has a chance of derailing your home loan application.

See also: Five ways to improve your credit score

Can you get a home loan if you have credit card debt?

Let's be clear, credit card debt will impact your home loan application. But it won't necessarily rule you out from obtaining a home loan.

How you handle your credit card debt could be key to your success.

Some lenders may be prepared to lend to you if they can see you're making repayments on time or, better still, making an effort to reduce your credit card debt.

While some lenders may reject you outright, others might let you borrow from them but at a higher interest rate.

An experienced mortgage broker can be invaluable in guiding you towards lenders whose policies may be more sympathetic towards applicants with credit card debt.

Do lenders consider your credit limit when applying for a home loan?

When lenders assess home loan applications, they examine your income, expenses, and existing debt arrangements. Even if you don't have significant debt on your credit cards, they'll still be included in lenders' calculations.

According to Reserve Bank of Australia data, Australian adults hold an average of 1.3 credit cards, meaning many people have more than one. These may have varying limits and balances but, whether they're used or not, many lenders will consider the cumulative limit of your credit cards when they assess your home loan application.

This may come as a surprise to some as many people assume lenders won't be too worried about cards that are sparingly used or carry very little debt. But that's rarely the case.

Rather than the debt your credit cards carry, lenders will focus on your credit limit which they will classify as existing debt whether you've accessed it or not. In simple terms, in the eyes of many lenders, you could be capable of maxing out your credit cards at any time.

How the numbers work

As a rule of thumb, a monthly credit card repayment is typically about 2-3% of the card's closing balance. Many lenders will calculate your regular credit card repayments to be 3% of your credit card limit.

For example, if you've got a credit limit of $10,000 across two cards, lenders can assume your minimum monthly payment to be around $300 per month. They'll apply this whether you've maxed out your limit or owe nothing on your credit card accounts when you submit your application.

As you can imagine, this can have considerable impact on your borrowing capacity.

To give you some idea, our borrowing power calculator can paint a picture of how your credit cards can affect the amount you'll be able to borrow.

Could having multiple credit cards hurt your home loan chances?

It is probably no surprise that having several credit cards can sound alarm bells for lenders, leading them to suspect you're living beyond your means.

As we've mentioned earlier, your lender will look at your combined credit limit when you apply for a home loan. This means that the more cards you have, the higher the monthly credit card payments your lender will assume you're paying.

If you're using multiple credit cards to organise your finances, you might consider calling your providers to lower the limits to the bare minimum.

By doing this, you not only put a lid on temptation to use your card for anything outside of essential expenses, but you'll also put yourself in a better position to get a loan when it comes time to apply for a mortgage.

Should I close my credit cards before applying for a mortgage?

The answer to this isn't as simple as you might think and there are a few factors to consider.

If you're looking to buy a home at the top of your borrowing capacity, it could pay to close your credit card accounts to free up extra borrowing power.

However, if you're not planning to get a loan for as much as you possibly can and you're responsibly using your credit cards, it can actually work against you to close your credit card accounts, as we'll explore below.

That said, if you're getting your finances in order to apply for a home loan, it's best to clear as much credit card debt as you reasonably can and lower the limits on each card.

See also: How to get rid of credit card debt

Overusing credit cards plunges your credit score

It should go without saying that if you're using your credit cards willy-nilly and missing repayments, or you're regularly exceeding your card limits, your credit score will be taking the hit. Of course, this can spell problems when you apply for a mortgage.

There are several strategies you can try to avoid overusing your credit cards. These include:

• Just keep your debit card/s on you for day-to-day purchases

• Start paying for small purchases in cash

• Don't buy anything unless you can pay for it upfront (an old-fashioned concept)

• Remove your credit cards from any online accounts

• Save your credit card for emergencies only

• Use an app that monitors your credit card use so you know exactly how much debt you're accruing

Can your credit card usage boost your chances of getting approved for a home loan?

As we've already touched on, responsible credit card usage could be a green flag for home lenders.

Using your credit card can actually improve your credit score, but only if you do it with caution. Paying for purchases with your card and settling the balance on time demonstrates a positive repayment pattern to potential lenders.

If you have existing credit card debt, make an effort to pay more than the minimum monthly payments on a regular basis. It could also be worth asking your credit card provider to reduce your limit to the lowest point that still meets you needs.

It all comes down to showing that you're responsible. Lenders like to see that you can handle debt and manage your finances well, so think about that before you use your credit card.

If you're worried your credit card usage could hamper your aspirations of buying a home, you might turn to a mortgage broker for personalised advice to help increase your borrowing power. They might also help you find lenders who are more relaxed about credit card use.

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Credit card or not, all homebuyers are aiming to secure the lowest home loan interest rate available to them. If you're hunting for a mortgage, here are some of the best offers out there right now:

Image by Blake Wisz on Unsplash