Does Credit Card Debt Affect Me When Getting a Mortgage?

Summary: This article explains how credit card debt can affect you when trying to get approved for a mortgage loan. Here are the key points of this article. Large credit-card balances can pump up your debt-to-income ratio, or DTI. Many lenders today limit borrowers to having a DTI ratio no higher than 45%. Excessive debt can also lower your credit score, as explained below. Both of these things can make it harder to get approved for a home loan.

How Credit Card Debt Affects Mortgage Approval

As a home buyer, you should be concerned with the amount of credit card debt you have, because it directly affects your ability to get a home loan. In fact, having too much debt can hurt you in two ways during the mortgage process:

  1. It can lower your credit score, which in turn reduces your ability to qualify for a loan.
  2. It increases your overall debt-to-income ratio, which also reduces your chances of getting a loan.

Lenders today are much more concerned with your total debt load, and they will turn you down cold if they feel you are carrying too much debt in relation to your income. How much is too much? That depends on the type of mortgage loan you’re trying to get. Suffice it to say that if your combined debts eat up more than 50% of your gross monthly income, you’ll probably have trouble qualifying for a home loan. (Refer to the “Debt-to-Income Ratio” section below for more on this.)

The bottom line is that credit card debt definitely affects your chances of getting a mortgage loan. It’s all about risk. Borrowers with heavy debt burdens represent a larger risk to the lender. So they have a harder time qualifying for financing. And if they do get a loan approval, they typically end up paying a higher interest rate due to the higher risk associated with all of that debt.

Problems Associated With Excessive Debt

There’s nothing wrong with carrying a small and manageable amount of credit card debt. It’s something that millions of Americans share in common, myself included. But when you have an excessive level of debt in relation to your monthly income, it can hurt your chances of getting approved for a mortgage loan.

Mortgage lenders use credit scores and debt-to-income (DTI) ratios to measure the potential risk a borrower carries. A borrower with a relatively low score and a high amount of recurring debt represents a bigger risk to the lender. This is exactly what can happen when you have a lot of credit card debt. It can lower your FICO score and increase your DTI ratio, thereby reducing your chances of getting approved for a loan. This “double whammy” is one of the most common causes of mortgage rejection these days.

So yes, credit card debt can affect you during the mortgage process — and in a big way.

Your Credit-Utilization Ratio

There is a direct connection between credit scores and mortgage loan approval. Here’s a quick overview of how these two things are related:

When you apply for a home loan, the lender will review every aspect of your financial background. Your FICO credit score is a big part of this review process. If you have a high score, you’ll be more likely to get approved for the loan. You’ll also qualify for a better interest rate, which could save you a lot of money.

But if your score is too low, you might get turned down altogether. Or you might get approved with a much higher mortgage rate, making the loan less affordable in the long run.

Your score is basically a statistical indicator of risk. The lower the number, the more risk you bring to the table (from the lender’s perspective anyway). And vice versa. This is why it’s so important to check these numbers before you start shopping for a loan or trying to buy a house.

Here’s how this relates to credit card debt. If your card balances are extremely high in relation to your card limits, it will lead to a reduction in your overall FICO credit score. In fact, the “credit-utilization ratio,” as it’s known, is one of the top two factors that influence your score.

The utilization ratio is part of the formula that determines your FICO score. This ratio is a comparison between the amount of credit you have available to you (your limit) and the amount you are actually using (your balance). For example, if you have a card with a $5,000 limit, and your balance is $4,400, then you have a very high utilization ratio. You are using most of your limit are nearly “maxed out.” This also shows that you rely too heavily on your credit cards. This would do you no favors when applying for a mortgage loan.

As you can see from the chart below, the amount owed on your various credit accounts (including those cards) drives 30% of your overall FICO score. This is shown by the red slice of the pie chart.

FICO Score Chart

This is one of the ways in which credit card debt can affect you during the mortgage process. If you have too much of it, it could raise a red flag within the FICO scoring system. It can reduce your score and make it harder for you to obtain a home loan. So check your credit score now to see where you stand. If it’s lower than average, start an “investigation” to determine the possible cause. If you have a high utilization ratio, you may have found the problem — or at least one of the problems.

There’s another ratio we need to talk about, because it too can affect your chances of mortgage approval. It’s called the debt-to-income ratio, or DTI.

Your Debt-to-Income Ratio (DTI)

When you apply for a mortgage, one of the first things the lender will do is check your debt-to-income ratio, or DTI. As the name implies, this is a comparison between the amount of money you pay toward your debts each month, and the amount of money you earn. This is one of the most important qualification criteria for borrowers who are applying for a home loan. It can make or break your chances of getting approved.

This is similar to the ratio discussed earlier, the credit-utilization ratio. But this one compares your overall debt to your monthly income. Mortgage lenders use the DTI to assess your financial stability and borrowing capacity. If you have a lot of debt already, relative to your income, you’ll probably have a hard time getting approved for a loan. This is all based on statistics. Lenders know that borrowers with higher debt ratios have a higher probability of delinquencies (missed payments) and defaults (ceased payments) down the road. They typically avoid lending to such borrowers in  order to reduce risk.

This is another area where credit card debt can affect your mortgage approval. Lenders are usually reluctant to offer financing to borrowers with DTI ratios above a certain level. Fifty percent is a common limit. This means that if your total debt load (including your future mortgage payment) uses up more than 50% of your gross monthly income, you could have trouble qualifying for a mortgage. Some lenders set the bar at 43% debt-to-ratio to coincide with new lending rules.

Read: DTI update for FHA and conventional loans

This is another reason why you should consider reducing your credit card debt before buying a home. If you’re carrying too much, it can drag down your credit score as well as your DTI ratio. And both of these things will make it harder to get approved for a mortgage.

Where to Find Legitimate Help

There are plenty of companies out there that would gladly take your money in exchange for their debt-management services. But many of them are unethical. They require upfront payments from their customers, and then they fail to deliver on their bold promises. Do a search for “credit card help” on the FTC’s website, and you’ll see what I mean.

But there are also legitimate non-profit organizations that can help you create a debt-reduction plan. They obviously won’t pay your bills for you — that’s your responsibility. But they can help you set up a budget, a payment plan and more. For starters, look into the National Foundation for Credit Counseling, a respected nonprofit organization.

You might want to consider talking to a HUD-approved housing counselor as well. They can give you advice on home buying, credit issues, choosing a mortgage and more. You can find a counselor in your area by visiting the HUD.gov website. They offer counseling services for little or no cost.

Conclusion and Going Forward

Using a credit card can actually help you improve your credit score, which makes it easier to get a mortgage loan. This might sound counterintuitive, but it’s not. It all comes down to how you use the credit you are given.

If you make occasional purchases with your card and pay the balance down each month, it creates a pattern of responsible usage. It shows lenders that you know how to use credit wisely, which is exactly what they want to see. Here’s what is says about this subject on the FICO website (the people who developed the scoring model that is used by most lenders):

“Someone with no credit cards, for example, tends to be higher risk than someone who has managed credit cards responsibly.”

The key word in this quote is “responsibly.” By keeping your balance(s) low, relative to your limit(s), you can create a long pattern of responsible usage. This will boost your score and make it easier to get mortgage loans and other types of financing. It also helps you qualify for better interest rates, which can save you a lot of money.

On the other hand, if you rack up a lot of credit card debt, you are creating a pattern of over-reliance and irresponsible usage. This can lower your FICO score. You are also increasing your total debt in relation to your gross monthly income, which raises your DTI ratio. Both of these things will make it harder to get approved for a home loan.