Credit Card Usage – What Lenders Want you to Know

Your credit card usage can make or break your mortgage loan approval. Lenders look not only at your credit score but also at your debt-to-income ratio, which includes the payments on your credit cards. So improper use of your credit cards could make it harder to get approved for a mortgage.

Since credit cards are revolving debt, you have constant access to the credit lines, which can put your mortgage lender at risk if it gets out of hand. Here’s what lenders want you to know about credit card usage to improve your chances of mortgage loan approval.

1. Don’t Carry a Balance

Carrying a credit card balance costs you more money because the balance accrues interest. Most credit card companies charge daily interest, which means your balance increases daily until you pay it off.

Carrying a credit card balance also shows that you use your credit card for purchases other than what you can afford. When your balance is high compared to your credit limit, it affects your credit utilization rate and credit score.

So not only does carrying a credit card balance cost you more in the long run, but it also gives lenders a reason to think you aren’t financially responsible.

This doesn’t mean you won’t get approved if you have any credit card balances. However, you should keep your credit card balances within what you can pay off each month whenever possible to manage your money and to show lenders that you are a reasonable risk when you apply for a mortgage.

What Lenders Want You To Know

Only charge what you know you can pay off that month. If you must charge something you can’t pay in full, make more than the minimum payment. For example, if your furnace breaks and you can’t afford to pay it off in full, break the balance into two or three payments to make it more affordable while paying the balance off quickly.

2. Don’t Use Your Credit Cards as an Extension of your Income

Credit cards aren’t an invitation to spend what you want. Lenders still want you to stick to a budget. When you use credit cards as an extension of your income, you end up in credit card debt.

Not only does it reflect poorly when you have a lot of credit card debt, but it also increases your debt-to-income ratio. Each loan program has a maximum DTI they’ll allow. Your DTI includes all monthly payments on your credit report, including your minimum credit card payment. Too much debt can increase your DTI and make you ineligible for a mortgage loan.

What Lenders Want You To Know

If you can’t afford a purchase, budget for it. Unless it’s an emergency, don’t charge it if you don’t have the cash to pay it off. Instead, figure out a savings plan so you can pay cash for the item and not put yourself further into debt.

When you apply for a mortgage, lenders determine your debt-to-income ratio. If your DTI is high because you make unnecessary purchases, it could cost you loan approval.

3. Watch your Credit Card Utilization

Your credit card utilization measures your total credit card debt as a percentage of your credit limit. For example, if you have a $1,000 credit limit and a $500 credit card balance, you have a 50% credit utilization rate.

Your credit score decreases if your credit utilization rate goes up beyond certain limits that differ by credit bureau and the grouping of consumers that you fall into (called a scorecard). For example, suppose you are in a certain subset of consumers that is penalized if their utilization is 30% or more on one of the credit bureaus, rounded to the nearest percentage point. For every $1,000 in your credit line, you shouldn’t have more than $295 outstanding. This doesn’t mean you can’t use your credit card, but you should only charge what you can afford to keep your balance low.

What Lenders Want You To Know

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The credit card utilization used for calculating your credit scores is based on the balance as of your statement closing date. This includes your purchases from the current month as well as any balance carried over from the previous month. The ideal is for the balance as of the statement closing date to be low compared the credit limit on every card, but to have a non-zero balance reported (from the new purchases only, so that you aren’t being charged interest) on at least one card.

The easiest way to manage your utilization rate is only to charge what you can pay in full. However, depending on your credit card’s due date, your credit card balance may appear on your credit report. This happens even if you pay the balance off in full by the due date. So if the dates cross, you may look like you have a high credit utilization rate on your credit report.

To find out if this is the case, pull your free credit reports (what website can we link to?) and check the date your credit card companies report your balances. The dates may cross if you show a balance even though you paid it in full. To avoid this, pay your entire balance when the bill arrives rather than waiting for the due date.

4. Don’t Pay your Credit Card Bill Late

Make all credit card payments on time, even if you only make the minimum payment. Late payments hurt your credit score the most. Your payment history is the most significant part of your credit score. It makes up 35% of your credit score –  A single 30-day late payment could cause your score to fall significantly.

Not only does a late payment hurt your credit score, but it shows lenders you can’t keep up with your debts. To avoid making payments late, set up autopay or record the payment due date on your calendar.

What Lenders Want You To Know

Late credit card payments, even by one day, incur a late fee, but they don’t hurt your credit score. If you can’t make your payment on time, make it up within 30 days of the due date. If you pay it before the 30^th day, it won’t report late on your credit report, so your credit score doesn’t fall.

Final Thoughts

Credit cards may make tracking spending or earning rewards easy. But if you don’t use them correctly, they can hurt your credit and your chances of loan approval.

Mortgage lenders don’t use credit card usage against you directly; however, they do if it affects your credit score or DTI, or shows irresponsible use of your finances. Avoid using your credit cards ‘just because.’ Instead, use them wisely, ensuring you only charge what you can afford, showing mortgage lenders you are a reasonable risk and can afford your credit card usage and a mortgage payment.

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