Buying a home is a bucket list item for many of us, but it can be difficult to finance such a massive purchase. Especially if you have credit card debt — or no credit at all — you may struggle to persuade a bank officer to sign on the dotted line.
But understanding how credit works isn’t always easy. Here are the answers to three common questions about credit and how your credit card debt affects mortgage rates.
1. Does my credit card balance affect my ability to get a favorable mortgage loan rate?
Yes. Depending on your bank, most mortgage loan officers will want to know that you have the assets/cash to pay off your outstanding credit card balance. If you don’t, you may be subject to a higher interest rate.
Worried that you won’t get a loan at all? This comes down to your credit history. Credit history is the largest factor in determining your credit score, so if you’ve paid off card balances in full for some time, you should be OK. But if your history shows you defaulted on your credit card debt, you may have a harder time getting a loan.
Tip: Most lenders will check your credit in the final stages of loan approval, so don’t run up card debt right before your closing date. Even if you’ve already been approved for a favorable loan rate, this can cause the lender to cancel your loan or delay closing.
2. Will a lack of credit affect my future mortgage opportunities?
Maybe. There are ways to secure a mortgage loan even without credit. You can apply for a government-backed mortgage — or an FHA loan — which is designed for low-income, first-time homebuyers. There is quite a bit of paperwork involved (you’ll have to prove that you’ve paid rent, bills, etc.), and you’ll most likely be required to put down a larger down payment than is required with a traditional loan (20% down compared with as little as 3.5% down).
You also could ask someone with good credit to co-sign on a loan for you. If you don’t have any credit at all, the co-signer can help. Just make sure they understand that the payment of the loan will affect their credit report for years to come.
If you’d rather not ask a friend or family member to co-sign, and an FHA loan isn’t right for you, consider waiting six months to a year and using that time to start establishing good credit on your own. Keep your balance to less than 25% of your card’s credit limit and pay it off monthly.
3. What is the best way to pay off credit card debt?
There is no one right way to pay off the debt, but there are a variety of approaches. Consider consolidating your debt by transferring balances from your high-interest credit cards to a low-interest card. Be aware that transfers include fees, usually around 3% to 5% of the balance amount.
Then control your spending. Cut out unnecessary purchases. Even the smallest savings can really add up.
Finally, pay more than your minimum payment. This will keep your credit score healthy, which can help you land a mortgage loan in the future.