HOW DO CREDIT CARDS IMPACT MORTGAGES?
2016-09-28 | 06:58:26
When people think of credit cards and mortgages, one of the first things that often comes to mind is refinancing a mortgage to pay off large amounts of bad credit card and loan debt. However credit cards can have another significant impact – the effect they have on your credit score.
For those who don’t know, a credit score is one of the main indicators of our financial health – mortgage lenders use it along with your credit report when determining how big a mortgage, loan or credit card limit to offer you and at what interest rate. Having a low score could result in getting approved at higher interest rates — or even worst being declined. And today lenders are not the only ones checking – some landlords and employers do as well.
Equifax, the largest credit reporting agency here in Canada, has a database of over 24 million Canadians. The company tracks how we pay back all kinds of debt, including credit cards, lines of credit, bank loans and car loans. And starting a few of years ago – banks now report mortgage information to agencies as well.
Credit reporting agencies do ongoing statistical analysis on the Canadian population, in order to understand the probability of us not paying a loan back or making late payments and they then translate that probability into a score. Our individual score is always changing based on our ongoing credit behaviour. For example missed or late payments or “maxing out” credit accounts will lower your score. The best way to increase your score is to pay back debt on time and in a consistent manner.
Scores normally range from 400 to 900, with good scores typically 660 and above. Anything over 760 is considered excellent – and with anything over 700, a lender will normally consider it a no brainer when approving a loan or credit card application, assuming the other factors they look at meet their requirements.
Not making on-time payments
There are many factors that will impact how high or low your credit score is – however one of the more important ones is not making a payment on-time. Some people for example don’t make their minimum credit card payment one month thinking that it doesn’t matter since they plan to pay off the entire balance the following month. Unfortunately this is one of the worst things you can do. Missing or being late on a minimum payment, no matter how small it is, has the same effect in the eyes of a credit agency as missing a large payment.
Approximately 35% of your credit score is made up of your payment history, so missing even one payment can have an impact. Also remember a missed payment will stay on your credit bureau history for six years.
Not managing debt utilization
Another important factor – utilization ratio – is our level of indebtedness or how much total available credit we’re using. For example, if your credit card limit is $5,000 and your balance is $5,000, your utilization ratio is 100% — which isn’t a good thing in the eyes of credit agencies. The way they see it is that if you’re constantly maxing out your credit cards, it might imply that you are not far away from defaulting on your minimum payments. In other words it looks like you might be stretching your income too far and just getting by.
There are two rules for utilization ratios – one for those who pay off their balances in full every month, and one for the other 45 per cent of Canadians who carry a monthly credit card balance.
If you always pay off your monthly balance – don’t let your utilization ratio go over 70%. The best way of dealing with this issue is to set an imaginary limit of 70% in your mind and don’t go over that. Doing this will keep your credit score healthy. For example, if your credit card limit is $5,000, don’t borrow more than $3,500. And if you use your credit card to accumulate lender offered rewards and you’re going over this 70% mark trying to maximize them – you might consider talking to the lender about increasing your limit so your monthly spending always falls under this threshold. However remember that too much credit can hurt your score as well.
If you carry a balance on your credit card – in this situation try and keep the balance under 35% for a couple of reasons – first, this is close to the magic number for utilization ratio and contributes to a strong credit score, and secondly it helps to cap debt that you might not be able to manage. When a credit card company establishes a limit for a new card or increases your limit on an existing card, in most cases they’re not looking at your entire personal budget and might not be aware that you can’t afford to spend the maximum they’re offering because of other financial commitments and still pay it off in a timely manner.
Approximately 30% of your credit score is made up of your utilization ratio. Fixing your ratio is one of the fastest ways of improving your score.
By following these simple credit card best practices you won’t negatively impact your credit score and ultimately the chances for that mortgage you might need down the road.