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By Katie Levene
Exciting new things are on your horizon when you begin your home buying process. You may have started looking at houses and talking to a mortgage loan officer about how much house you can afford. It may be tempting to embrace the excitement by also applying for a new credit card with better rewards or a big promo.
Before you go ahead with a credit card application, you may be wondering if applying for a credit card affects a mortgage application. The answer is yes. A new credit card application before you close on a home could affect your mortgage application.
A mortgage lender will usually re-pull your credit before closing to ensure you still qualify and that new credit was not opened. Even if the new account does not cause qualification issues, it could cause a delay in the closing as the new credit account is verified.
A lender considers the following key factors when they approve your mortgage application: your credit score, your debt-to-income ratio, your down payment and your work history.
When you open a new credit card, a few changes will happen to your credit score, impacting your mortgage application. Your average age of credit may decrease, a new hard inquiry will show up on your report, your credit utilization ratio may decrease, and your credit mix may improve.
We’ll break down each of these changes to your credit score so you can better understand how a new credit card could impact any open loan applications you have outstanding.
Your credit score is an important piece to your mortgage application. Here’s how a new credit card can impact your score.
Average age of credit: Age of credit makes up 15% of your credit score. With a new line of credit, this factor may decrease your score.
Hard inquiries: Credit inquiries affects your credit score by 10%. Your lender or credit card issuer will do a hard inquiry or “hard pull” of your credit score and history when you apply for a new loan or card. Hard pulls can cause a short-term dip in your score, but they typically fall off of your credit report after 18-24 months.
Credit utilization ratio: Credit utilization makes up 30% of your score and looks at how close to your credit limit you are on all your lines of credit. For example, if you have a credit card with a $10,000 limit and have a $5,000 credit card balance at the end of the month, your credit utilization is 50%. For this reason, it’s important to consider how you are using credit cards during a mortgage application, not only opening a new card.
If you open a new credit card, your overall credit limit would go up, which could be good for your credit score. To keep your credit score in a good spot, experts advise keeping this ratio under 30%.
Types of credit or credit mix: Credit type makes up 10% of your credit score. This factor looks at all your active and closed accounts over the last seven years. A new credit card adds to your mix but experts recommend only getting a new card if you’ll use it, not to improve this part of your credit score.
When your credit score changes, the rate on your mortgage could change as well. A bump in your rate can make a big difference over the life of your loan.
Let’s take a look at what a difference in one percentage point on a 30-year fixed rate could mean for your wallet.
A $300,000 mortgage loan at 3.00% APR for 30 years would have a monthly mortgage payment of $1,264.81. You’ll pay $155,332.36 in interest during the life of the loan.
The same $3000,000 mortgage loan for 30 years at 4.00% APR would have a monthly mortgage payment of $1,432.25. You’ll pay $215,608.52 in interest with this increased rate.
A percentage point difference in your rate is a difference of $60,276.16. In other words, it’s important to do everything you can to protect your credit score when you know you’ll be purchasing a home.
Once you’re preapproved, you’ll begin a lock period. A lock period is the number of days that a rate will be guaranteed by your mortgage lender, typically from 45 to 60 days. It helps you “lock in” your interest rate when you close within the lock period, even if mortgage rates nationwide go up.
Many mortgage loan officers still recommend that you avoid opening any new loans or credit cards. The lock period is only good for your preapproved loan amount and property type. If you decide you want to make a change or if your closing date is after your lock period, your rate may change.
Before and during a mortgage application, there are a few things you can do to help ensure you put your best foot forward. Keep making monthly payments on your loans and bills on time, every time, so you have a great payment history. Also, avoid opening any type of new loan including auto or personal loans too close to your mortgage application. Refinancing a loan such as a student loan counts toward a new loan as well. Finally, check your credit report for any inaccuracies and make a plan to correct them.
If you have any questions about best practices when applying for a mortgage, ask your mortgage lender. They are there to help!
In the meantime, check out these homebuying tips:
Katie Levene is a marketer fascinated with finance. Whether the topic is about the psychology of money, investment strategies or simply how to spend better, Katie enjoys diving in and sharing all the details with family, friends and Money Mentor readers. Money management needs to be simplified and Katie hopes she accomplishes that for our readers. The saying goes, "Knowledge is Power", and she hopes you feel empowered after reading Money Mentor.
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