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My wife and I have been paying off debts since we got married about 3 years ago. We have about 15k left in credit card debt, 1 car loan, and 2 student loans (one is very negligible @ < 4.5k). The original plan was to pay off all our credit card debt before getting a house, but we'd like to try to get a house 12-18 months. We're starting to put back money for a down payment (yes, I know my 1% interest is peanuts compared to what I'm paying to the credit card company) while also paying extra toward our balance.

In the process of paying off debts, we've paid off some really stupid ones (department store cards). So, now we have 8 paid off cards, and the one with the 15k balance. I'd read a while back that having low balances can be a red flag to lenders, as they fear that you might charge up your cards after getting a mortgage and not be able to pay the monthly payments. I'm thinking its fine to just close the 6 store cards that are paid off, but I'm unsure about what to do with the 2 credit cards. One is a high limit, is my oldest card, and has an annual fee. The other I am more comfortable keeping because it keeps a lower rate, no fee, and has a very small limit. Then there's also the issue of the 15k card, which is out of about 17k...so it's at high utilization.

We make about 104k per year, salary wise. What percentage of balance should I aim for on the remaining card, and how many of the paid off cards should I keep in order to be in great position for the best mortgage rates?

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4 Answers 4

up vote 3 down vote accepted

The old underwriting standards were 28% home debt to income ratio and 33% consumer debt to income ratio. Consumer debt is calculated based on minimum payments. Now, most models are revised upwards... I believe 33/38 is more common today.

As long as you are current on the accounts, closing credit or store revolving accounts will have little or no bearing. Just leave them dormant... there is no positive result from closing accounts that have no balance.

Having low or no balances has NO negative impact on your credit score. Low balances are NOT red flags to lenders. Period.

Here's a quote from Fair Issac:

It's just not true that you can have too much available credit. That by itself is never a negative with the score. Sometimes the things you do to get too much can be a problem, such as opening a bunch of new accounts, but for the most part, that's just kind of an old wives' tale.


The major drivers of credit scoring are:

  • On-time payment history
  • Length of credit history
  • Utilization of total unsecured credit lines. If you have $50,000 in credit lines and $45,000 in debt, you are in trouble. If you have $50,000 in credit lines and $0 in debt, you are in good shape.

To improve your prospects for getting a mortgage, you should be reducing your spending and focusing 60/40 on saving for a down payment and paying down that $15k credit card, respectively. Having cash for a down payment is critical to your buying power, as zero-down loans aren't widely available in 2011, and a large downpayment will allow you to eliminate or reduce the time you are paying PMI. PMI reduces your buying power, and is a big waste of money.

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1  
Can you clarify your example on utilization? You use the same numbers twice. –  Alex B Mar 15 '11 at 17:03
    
One of the dangers of cut & paste! :) –  duffbeer703 Mar 15 '11 at 21:40
    
This answer can use a bit more math. The cards can fall between the 28/33 limits or 5% of income, just over $400/mo. So, in effect, up to $400/mo in required card payments should have no impact on the amount OP can borrow. And I strongly agree avoiding PMI is great advice. –  JoeTaxpayer Sep 14 '13 at 0:59

From a slightly different perspective, in my experience of buying a house you will find some unexpected costs due repairs that need to be made which were overlooked during the home inspection etc. You will need some financial cushion to fall back onto for these unexpected costs so for that reason alone I'd try to pay off as much of the credit card debt as I can.

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I would aim for 10% or less, because I believe 30% is where you start to get dinged on your credit score. No one will know for sure, as there are many models, but 30% is brought up by radio host Clark Howard pretty often.

Close annual fee cards or one store only cards. Normally I would suggest "leap-frogging" your credit cards so that as you open a new one with no fees, you then close another that does have fees. However I do not think opening lines of credit with an upcoming home purchase is a good idea. It will reflect negatively that you are opening credit all over then place.

I would shoot for such a low percent to make sure that the time it takes for reporting to happen will happen. Also, as you gear up to buy a house, make sure your credit report is clean looking with all of these balances and cards you are considering closing.

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Your total debt is equal to your total non-credit debt (student loans, car loans) + your total available credit. This is the truth of the "low balance" fear from lenders that you had heard about.

Your credit utilization is across all of your cards. So if you have two cards, both with 15K limits and one is maxed out and one is empty, that is 50% utilization. If you have both cards with 7.5K balances, that is also 50% utilization.

For the 8 cards that are paid off and still open, after you buy a house, I'd close any cards you aren't using. Not everyone will agree with this.

If possible, I would close the 8 cards now and pay off the 15K balance before buying a house. If it's hard to pay it off now, it will be harder when you have a mortgage and home maintenance costs.

If you want to buy the house before you pay off all of your credit card debt, I'd still close the 8 cards that are already paid off and pay down your last card to 4K (or less) to get under 25% utilization.

The credit rating bureaus do not publish exactly how a different utilization rate of credit will affect your score, but it is known that lower utilization will improve your score. FICO calls this "Proportion of credit lines used (proportion of balances to total credit limits on certain types of revolving accounts)"

Also, the longevity of your credit history is based on type of account (credit cards, car loans, etc.) so if you keep one credit card open, you still keep your long "history" with credit cards on your credit report. FICO calls this "Time since accounts opened, by specific type of account"

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That makes sense. So 25% of total revolving credit is what I should shoot for? Across the board, counting both our credit limits? –  JustinP8 Mar 14 '11 at 20:29
    
+1 but I would strongly consider keeping at least a couple few of the better cards open. Close those store cards or annual fee cards though. –  MrChrister Mar 14 '11 at 23:41
    
-1 Closing 8 accounts has absolutely no positive impact in getting a mortgage, and is more likely to have negative impact on credit score. –  duffbeer703 Mar 15 '11 at 0:30
    
@duffbeer703 Thanks for the feedback, Do you have a link that I can reference. I can't find anything that says having open, $0 balance accounts or closing $0 balance accounts makes a difference to credit score. The FICO page I referenced says the number of accounts with a balance affects your credit score, but doesn't discuss $0 balance credit cards. If there is no affect on your credit score, I'd close the accounts. –  Alex B Mar 15 '11 at 17:01

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