What will it take to have your mortgage application approved? If you ask someone this question, they will probably talk about requirements such as income, credit history, and having money for a down payment. Obviously, these are the most important things which influence the decision. But there’s something else you also need to consider… your credit cards.
Depending on how they are used, your credit cards can help – or hurt – your chances of being approved for a mortgage.
How Can They Hurt You?
Everyone already knows that late payments or defaults on an account will negatively impact your credit. That’s pretty obvious, right? Well that’s not what I want to talk to you about. Rather, let’s talk about some of the lesser-known reasons they can hurt you.
1. Applying for new cards right before a mortgage
Every time you apply for credit, a so called “hard” credit inquiry (credit check) is performed. These are saved on your credit report for a period of time – in Canada an inquiry is typically purged 3 years from the date it was made.
So why should you care about having inquiries on your file? Because they affect your credit score!
That means you don’t want to make a hobby out of randomly applying for credit cards, especially in the months before your mortgage application. Even though the inquiry remains on your file for up to 3 years, it has the greatest influence on your score during the first 6 months (and as they become older, their impact diminishes).
2. Using too much of your credit limit
What percentage of your card’s limit do you use? That’s important to consider, because it affects your credit score; using too much of your available credit will hurt you.
Since the credit scoring formulas are secret, no one can say precisely how much is too much. But the consensus is that it’s best to never use more than 20% or 30% of your limit. So for example, if you had a Visa card with a $10,000 limit, that would mean never using more than $2,000 or $3,000.
Even if you pay your credit card bills in full every month, you still should pay attention to this. Why? Because creditors will usually report the amount reflected on your monthly statement when it closes (that means, before you pay it).
So if you plan on applying for a mortgage soon, don’t use your credit cards too heavily.
3. Letting your cards sit dormant
Many people have several credit cards they’ve collected over the years, but they only use one of them on a regular basis.
If an account remains dormant for a long period of time, the creditor may stop reporting it on a monthly basis to the credit agencies. Furthermore, it is suspected that the scoring formula counts inactive accounts differently than active accounts.
For these reasons, it’s always a good idea to “dust off” your unused accounts at least once every 3 or 4 months. By simply making a purchase (even it’s something inexpensive, like a cup of coffee) it will keep the accounts active.
How Can They Help You?
The good news is that if you manage your credit cards the right way, they can be extremely useful in helping you get a mortgage. Here are a few reasons why.
1. Credit diversity is important
To achieve a high credit score, you will need to have a mix of accounts. That means you can’t have only loans or only credit cards on your report. Instead, banks like to see a diverse mix of accounts. This demonstrates to them that you know how to manage different types of credit.
The types of accounts fall under 2 categories:
- Installment Loans: Basically any type of loan will fall under this category. Car loans, student loans, mortgages, etc.
- Revolving Credit: This is a type of account that doesn’t have a fixed number of payments. For the most part, the only thing in this category is credit cards.
To achieve the best credit scores, you should have accounts which fall under both of these categories.
2. When paid in full there is no interest
One of the best things about credit cards is that they allow you expand the number of credit accounts you have, without having to pay interest (assuming you pay your cards in full and on-time). Contrast that to a loan, in which you will always be charged interest.
For this reason – when managed responsibly – credit cards are perhaps the most convenient route to achieve a higher credit score.
3. There are credit cards to rebuild credit
With bad credit you can’t get approved for a loan or mortgage, but you can get approved for a credit card.
If your credit score isn’t good enough to get approved for unsecured lending, then you should consider getting a secured credit card.
With these types of cards, you put up a security deposit which becomes your line of credit. For example, if you put up a $1,000 deposit, you would have a $1,000 credit limit. Best of all since you are basically guaranteeing the risk, you can usually get approved for these cards no matter how bad your credit history may be.
Loans Canada has compiled a ranking of the best credit cards to help you rebuild your credit: Go here to learn about secured credit cards.
If your credit isn’t good enough to get approved for a mortgage or other unsecured line of credit right now, then the above link is your best bet. It will show you how to open a secured account so you can begin building your credit and start preparing for a mortgage down the road.
