Here I'd like to share about the various ways that credit cards can impact the home buying process, including credit card pitfalls, credit card utilization, late payments, collections, closing old accounts, opening new accounts, and choosing new credit cards.
Some would argue that it's best to not use credit cards at all. If you can overcome the 5 main pitfalls that I see hurting people, I recommend using credit cards responsibly to enhance spending. I am saving around $10,000 in the year of this writing alone through credit/charge card points, cashback, and miles. That said, due to the pitfalls, most people have good intentions when it comes to credit cards, but lose more money than they would ever earn.
Credit Card Pitfalls:
1. Carrying a balance & getting charged interest
This problem not only does not help people's credit, as some have been mistakenly told, but it also is costing most much more than any benefits they receive from credit cards. This problem is one of the main ways that people get into major debt.
2. Impact on Budgeting
Many think that if they're not carrying a balance, they're responsibly using their credit cards. Many of them are wrong. If you are not actively working to ensure that your budget is not negatively impacted psychologically by credit cards, you're likely still losing more money than you're getting through credit card bonus incentives. The best way to work around this is by running a tight budget, using the Mint.com/Mint app credit v checking account difference, & paying your balances in full in advance.
3. High Utilization
There's another potential problem even when paying in full every month for some people on some cards. In some cases, even though they pay in full every month and have a good budget, they can still experience high credit utilization. I recommend paying in advance of when the account is due if you're ever above 20% utilization for a month prior to needing to use your credit for anything, such as a mortgage or applying for credit cards, and the lower your utilization, the better (I like to keep my total utilization under 5%). That's on all of your cards together and individually. I've seen my own credit score temporarily dip substantially from one of my lowest limit cards having 86% utilization, even when I was paying in full automatically every month & my total utilization across all accounts was still <5%. The good news was that the next statement after I paid it off, my credit score went right back up where it was before. While many aspects of credit have a long-term impact, utilization is not one of them, so decreasing your utilization if your utilization is high can shoot your credit score up fast.
4. Annual Fees
While some annual fees can absolutely be worth it, it's important to keep in mind that not every credit card is a good card to get, and that some cards are better for some people than others. I recently recommended that someone cancel multiple charge cards where I did not believe that he would be able to maximize his spending on them & where he could do better with other cards he already had available.
5. Hard inquiries and average credit age
If you don't have any form of credit, getting a secured card is a great way to establish it prior to buying a house. Getting a credit card can also help if you have high utilization on another card and are unable to pay it all off prior to buying a house. When nothing like either of those apply to you, and your credit score is below 760-780 (depending on the minimum credit score needed with the lender you're working with to get the best rates - this is often 740 or 760), I usually do not suggest getting a credit card within 1-2 years of buying a house. The reason is that while those two cases usually end up with a credit card raising your score, in many other cases, you will temporarily have a lower score for 1-2 years. Giving yourself a 20 point buffer might be enough for your credit to remain above the lender's minimum for the best rates. If you only have 1-3 cards, especially if those cards are old, you might have a more negative impact than 20 points, so in that case, I would recommend a larger buffer. After 1-2 years, especially if your average age of credit is only a few years, your credit can often recover from the negative impact of hard inquiries (which do not count against you after 1 year even though they remain on your report for 2 years), as well as the impact of a lower average credit age.
Responsible use of credit cards, including low utilization, paying your bills in full on time automatically every month, can increase your credit score more so than if you never had any credit cards, in my opinion and in the opinion of many lenders. If you're unable to use credit cards responsibly, it's best to begin using only debit cards except for a small amount (less than 50$ a month) on credit cards to keep them active while making minimum payments plus as much as you can wisely afford extra (after budgeting well, a step which too many people skip and pay for) on the card with the highest interest rate where you carry a balance. It is best to not close accounts unless you are paying an annual fee, and even then it can sometimes not be best, such as if it's your only card or your oldest card and you plan on applying for a mortgage soon. Responsible use of credit cards can save you money and increase your credit score, while irresponsible use both decreases your credit score and can cost you in fees, higher spending, interest, etc. To effectively use credit cards, I recommend always paying in full each month. Otherwise, the interest charged is likely greater than the rewards you earn. There are some exceptions, including 0% APR introductory bonuses, although if using that for large purchases, know that if your utilization gets above 10%, it could still hurt your credit score.
The Impact of Credit Cards on the Home Buying Process
While unpaid or late credit cards can have a negative impact on the home buying process by lowering someone's credit score, those unfamiliar with credit could also be negatively impacting their credit even if they always pay on time in full. Credit card utilization is an important factor in your credit score. Utilization is important for individual cards as well as the total utilization of all of your cards combined. Utilization is the percentage of your credit that you are using at any given time compared to the credit limit of that card or those cards. It's best to stay below 30%, and ideally you want to stay as close to 0% as possible while still having at least a little activity on each account monthly. I saw one of my scores drop 19 points when, with all other factors staying the same, I increased my overall utilization from below 10% to 18%, simply by increasing what I owed on one card (my highest limit card) to 29%.
See what happened as I track it on Creditkarma here:
Keep in mind that I always automatically pay the full amount owed on credit cards, sometimes paying it off manually prior to the automatic time. That 19 point drop was no exception; the only difference for 19 points was a shift in utilization. On another occasion, when I let myself get to 42% on that same highest balance card, all other factors remaining the same, I saw one score suddenly drop by over 60 points (not pictured). It also depends on when your credit cards report to the CRC's. I contacted that credit card company, they told me plainly, so now I know to have it paid to less than 10% for a few days around that time of the month. Needless to say, now that I know the impact it can have, I never plan on going above 10% on total utilization or on a high limit card like that again when close to the report date. On the other hand, I often go between 0-20% of my limit on my lowest limit card, without seeing any impact on any of my credit scores.
You can decrease your utilization through a variety of ways.
You can ask for your credit limits to be increased. It's best to wait 6 months to a year between requests to increase your credit limit. It's also best to call them to increase your limit, asking beforehand whether or not it will cause a hard credit inquiry or a soft one. Some will only have one or the other option, while others will have both options. While a hard inquiry increase could increase your limit more than a soft inquiry would, you might not want another hard credit inquiry on your score, especially if you've already had some in the past year. Hard inquiries for credit cards count negatively against your score for one year and remain on your report for 2 years.
You can pay your card off prior to the end of the month. One way to do this is to setup automatic alerts when your card's utilization gets past 8%, for instance. You can then pay cards off manually in less than 30 seconds through Mint Bills on your smart phone if you have a smart phone with a fingerprint reader. When paying off cards manually in between automatic payments in full, I recommend leaving a small balance, such as $10 or $30, on the account.
You can also always decrease your spending in credit cards (shifting to debit cards that give you some cash back like Discover's Cashback Checking Debit Card) or spread out your bills more between accounts, putting a lot into your highest credit limit card. These last 2 options are a last resort unless you can find no better alternative and the other two methods of paying your bill early or increasing your limits have not worked for you.
Late payments & collections will most often have a negative impact on your credit, often more so than utilization. By checking your credit report through annualcreditreport.com (great with accuracy) or Creditkarma.com (great for more regularly checking your report while losing some accuracy) you can freely see which accounts are in collections. At the time of this writing, yesterday I walked someone through the process, where they found out that they would be able to eliminate 2 collections accounts by as little as $200. By contacting the collections agency prior to paying, you can often get them to agree in writing to eliminate the collection account from your record if you pay it. If you do not go through this important step to contact a collections agency prior to paying off a collections account, it is extremely difficult to get a collections agency to remove a collections account after it is paid off, and paying it off can have more of a negative impact than a positive impact temporarily. Paid off medical collections stop affecting your Vantage credit score, however that score's used by less than 10% of lenders, while most use the FICO scoring system. With the FICO score, paid off collections do not drop off your record until 7 years later.
When you close old accounts, with other accounts still open that are newer, you immediately shift the average age of your credit to be younger, negatively impacting your credit score. If you're paying an annual fee on this card, it might be worth it, but that will depend on your situation, such as other accounts that are closest in age to it, the total number of accounts, and if you need the maximum credit score right now. If your credit score is 700 right now, for instance, and you are trying to build it to 720 prior to purchasing a home with a conventional loan, you probably wouldn't want to close an old account if it was your oldest account by far even if it had a $200 annual fee. On the other hand, closing your youngest account could boost your score if you have other accounts of the same type (such as closing one credit card and leaving other older credit cards active).
When you open new accounts, you usually negatively impact your score temporarily by shifting your credit age to be younger, including "new accounts" in your report (which is a factor in itself - less than 2 years), and usually by the hard credit inquiry necessary to acquire a new account. The more cards you have, the less temporarily negative impact a new card will have on your credit. Sometimes, opening new accounts can immediately positively impact your credit score, but this is only when the negative impacts are outweighed by other positive impacts. For instance, if you are maxed out on your only credit card with a limit of 500, and open a credit card with a limit of 10,000, your total utilization will drop dramatically, and the good could outweigh the bad, leading to a potential immediate credit score increase, depending on your situation. I have also seen where my utilization was only minorly impacted (from 4% utilization to 3% utilization), but because the new account had such a large credit limit and I already had so many other cards, it positively impacted my credit. Another possible exception would be if it's your first credit account of that kind, such as your first credit card or first installment loan, where you would positively impact your credit diversity, a factor in your credit score. If you don't have any credit score, get a secured credit card. I recommend the Capital One Secured Mastercard. I compare it with another decent yet inferior (in my opinion) option of Wells Fargo here.
For credit card recommendations I have for those that qualify, for my reviews of those cards, and for links to more reviews and information, click on the following for a personalized report here. Keep in mind that a lot of reviews out there are determined in part by advertisers, whereas mine are determined strictly based on rewards. Look at the disclaimers whenever looking at another group of reviews even if they look a lot prettier than mine. For instance, the top 5 non-Google ad sites that come up on a Google search of "best credit cards 2015" at the time of this writing are all paid for by advertisers. The top site, Creditkarma.com, has a disclosure that starts, "The offers that appear on this site are from third party advertisers from which Credit Karma receives compensation." On NerdWallet, on the top left you find an "Advertiser Disclosure" that you can click, which states, "Many of the credit card offers that appear on this site are from companies from which NerdWallet receives compensation."
While I recommend a personalized report, for the best non-biased, professional & numerical comparative that I've found for cash back rewards, click here. Keep in mind though that there are a number of limitations of that site, including the exclusion of the value of card benefits and points earning cards.
When using that site, I recommend both inputting your actual expenses (hover your cursor over the number that you spend per month to expand to categorize spending) for one search, and running searches with all of your spending in one category for each category. For instance, run a search with 200 spending in a month with 200 spent on gas. See how I set that up using that site here:
Then run another search with 200 in a different spending category, etc. It's important to choose a number in the ballpark of your actual spending in that category, because sometimes there are limits on the amount of cash back you can get per quarter or per year. This process enables those open to 4 or 5 cards to maximize their cash rewards since a search is based on only 1 card. You can get one card that is best for each category. Keep in mind as well that multiple credit cards is better for your credit than only one. There are limitations here, and you'll find that some of my recommendations cannot be found using this method. Following review of my site &/or Magnify, I recommend looking at 3rd party reviews. For the second best (a distant second) professional & numerical comparitive, look at Nerdwallet's here. It doesn't have nearly the search pool that Magnify does, so it excludes some great cards, but one advantage is that it lets you search by credit score, something that I prioritize as well in my own recommendations.
It's always important to check and see the likelihood of you receiving a credit card prior to applying for it. This way, you don't waste hard inquiries (each of which temporarily lowers your credit) needlessly on cards that you're unlikely to be approved for. I recommend a 2-3 pronged approach. First, know your FICO score, at least the ballpark score which you can get on Credit.com. Second, log on to Creditkarma.com, and see what they say is the likelihood that you'll get the card. If it's very likely that you'll get it, then check to make sure that your FICO score from Credit.com is above the average score listed for that card on Creditkarma.com.
See how I can do that with specific cards I'm considering on CreditKarma here:
Also note that the less history with using credit cards that you have, the lower your chances of getting a card, even if your score is very high. Notice that for whatever reason, my odds for getting the Amex card is only "Good" while my odds for getting the other cards is "very good" despite the fact that the numbers would indicate otherwise. Approvals is more than simply your credit score. I have a friend who was denied the first credit card that she ever applied for, a Citi Double Cash Card, even though Credit.com said that her score was over 750, which is above the average for that card of 732 (Creditkarma.com on 7/23/15). If she had been using credit cards for years, it's likely that she would have been approved. It's also likely that her score would have been even higher, but even without that, she still would've probably been approved for having a history of responsible revolving credit usage. She applied for the Capital One Quicksilver card, and was readily approved. Third, I suggest checking your likelihood on Nav.com, which can give you the most detailed information about what will increases the chances of an approval for a specific card. Fourth, it's good to do some online research into the specific card that you're applying for. Some banks will frown on certain activity despite an otherwise good score with good revolving credit usage history. I look to use Google for this one, and will sometimes find myself looking through reviews and posts with many responses about applying for a particular card.
If you do get denied, and thought you would get it after doing the research, call reconsideration. Here's an article on the process here.
For more tips on credit card usage, make sure that you're getting accurate information, as there is much inaccurate information along with accurate on the internet, such as in this review that is ranked very highly in search engines that you can see here. I disagree with the first bullet point of #1 in that I would recommend getting the credit cards that you can use responsibly to maximize your savings. I disagree with #2 in that my list of recommended cards has 6 good rewards cards that you can possibly get with a 670-710 credit score. Other cards can be helpful to build credit, so even if you're below 670, I have other cards listed there that can help you build credit. For number 6, staying below 10% on all your cards is preferable for a maximal score. With number 10, talk to a lender to see if a credit card would be a positive or a negative for building your credit score within 1 year of applying for a mortgage. Sometimes it is beneficial for your credit score within a few months after a revolving credit line is opened.
Note: The content on this site is not provided by a bank or issuer. Opinions expressed here are author's alone, not those of a bank or issuer, and have not been reviewed, approved or otherwise endorsed by a bank or issuer.