How your credit cards could impact your home loan

By Gerv Tacadena

Here are some of the things you should know about your credit card and how it can affect your home loan application.

There is no doubt that having a credit card is a huge plus in your wallet — aside from getting perks and offers from different merchants, credit cards make payments easier and convenient. Wielding plastic will also help you build your credit score, which is a good thing when you are planning to take on a large loan for big purchases such as a car or a house.

However, do not use your credit card too much, as it can derail your home-loan application. Some borrowers might think having several credit cards will help them build their credit score as a low-risk borrower while others think paying their balance monthly will boost their borrowing power.

Here are some of the things you should know about your credit card and how it can affect your home loan application:

1. Lenders consider your credit limit when applying for a home loan
When banks assess home-loan applications, they look at not just your income but your expenses. Under the expenses umbrella, they examine your existing debt repayments.

You might think that they will only consider how much you pay for your credit cards monthly — meaning, if you never really used your cards, this item in their computation will be zero. However, lenders do not typically look at your credit card payments or your balance. Rather, they will look at your credit limit and base their assumptions of your credit card usage there.

Lenders use credit card limit regardless of whether you use it or not. Oftentimes, they assume that your monthly repayment is roughly 3% of your card's limit. The higher the limit, the lower your borrowing capacity will be. This is because they see your credit limit as a plausible debt level in the future.

You can use this calculator to estimate your borrowing capacity using your annual income and monthly expenses.

2. Having multiple cards will hurt your home-loan application.
Possessing several credit cards is a huge red flag for lenders, leading them to suspect that you are living way beyond your means. What would make matters worse is the credit limit each of your cards has.

As mentioned earlier, your lender will look at your 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 have.

3. Overusing your credit cards leads to terrible credit score.
If you use your credit card too often to the point that you exceed your card limit, then you are in big trouble when you apply for a mortgage. Not only will this ruin your credit score, but it will also increase your overall credit utilisation ratio significantly. This ratio tells your lender how much credit you have already used vis-a-vis the credit available to you.

4. Shutting down a credit card account only ruins your credit score.
While shutting down a credit card is a strategic move, it is not advisable to do so when you are about to apply for a home loan. Closing an account if you have a huge credit card debt will also not improve your credit score.

How does your credit card affect your credit score?
Your credit score works the same way as your grade point average (GPA) when you were still in school. As a good GPA unlocks good scholastic opportunities, a high credit score leads to better financing deals and lower loan rates.

Banks look at your credit score as an indicator of risk — the lower your credit score is, the riskier you appear to your potential lenders.

How you use your credit card affects your overall credit score. If you do not pay your bills on time or miss several of the payments, do not expect for a good credit report. A single instance of missed credit card repayment has a high chance of derailing your home-loan application.

However, rejection is not always the case with a poor credit score. Some banks might let you borrow if you have a low credit score, but they will likely give you a higher interest rate.

How should you use your credit card to boost your chances of getting approved for a home loan?
It all boils down to how responsible you are as a credit card holder. Using your credit card will actually improve your credit score, albeit only if you do it with prudence. If you pay using your card and you pay the balance promptly, it creates a good borrowing-paying pattern which your potential lenders can see.

You can also ask your bank to lower your credit limit. Try as much as possible to reduce your limit to the lowest level possible. Doing so will let you hit two birds in one stone: it will increase your chances of getting your home loan approved and you will get to control your credit card usage.

Being responsible is the key here. You would want to show your banks how good you are in servicing your debt and in handling your finances. You can consult a mortgage broker to check your options. They may help you find lenders with more flexible rules when it comes to credit card usage. Brokers can also guide you to determine the steps you need to take to ensure your credit card does not reduce your borrowing capacity significantly.

Curious about how much you can borrow for a home loan? Talk to an expert for free!

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