Everyone hears the credit advice flying in the mortgage process. Examples may include “You need to pay off all your debts!”. “Close your unnecessary credit cards!”. Too often we see clients do things like these that hurt their purchase or refinance closing. These costly mistakes stem from two primary areas. First, borrowers just get bad advice from others who are not knowledgeable on credit. At a minimum, many providing the advice have never even seen the borrower’s credit report. Next, borrowers have good intentions but do things that actually hurt credit scores. So today let’s discuss common credit mistakes that can cause closing issues.
Credit Mistakes: Paying Off or Settling Collections
It doesn’t make sense, but paying off an old collection can actually lower credit scores. Although there are plenty of times that underwriters require borrowers to pay off collections. What do you do? If allowed, either pay off the collection just before or at closing. Then the negative impact wouldn’t happen until after closing. Sometimes a collection company may even agree to remove the account completely from credit if paid off. Foremost, remember that they are a collection company and will say anything to get paid. So get any agreement in writing prior to paying off an account. Before doing such, consult with your loan officer!
Credit Mistakes: Closing Revolving Accounts
Revolving balances compared to credit limits account for 30% of a credit score. So closing revolving accounts reduces the available credit and can lower a score. Actually check out “What to do with those old credit cards that could help your credit scores“. Opposite of closing an account, companies will ask you to raise your credit limits. This is ok as long as there is not a credit inquiry. We discuss credit line increases in detail here.
Credit Mistakes: Paying Off Auto or Student Loans
Now paying off debts is generally a very good thing. But there are several bad results that can come from this during the mortgage process. First, don’t pay off a debt unless your mortgage expert tells you to. If required by underwriting, ask about paying it at closing. Sometimes loans with 10 or less payments remaining are not even counted in debt ratios. So why pay it off in this case? Additionally, paying off a debt reduces assets. Assets are key to a mortgage loan as it is used for down payment and/or reserves after the closing. Finally, paying off an installment loan shortens your length of credit.
Credit Mistakes: Open New Accounts or Apply for Credit
Ok, the obvious is new debts increase a borrower’s debt to income ratio. Higher ratios means qualifying for less of a loan. But new accounts during a mortgage process means additional verification steps. This means more work for you. Also new inquiries can reduce a credit score. What if you have a 640 score, open a new card, and then lose just 1 point. The difference in a 639 and 640 score can be huge with rates or even qualifying period.
Credit Mistakes: Increase Credit Card Balances
Again, balances on revolving accounts is the second most important factor in a credit score. Actually it accounts for 30% of scores! So if you have a credit limit of $500 and your balance goes from $20 to $450, a score can decrease dramatically. Especially true if you have limited open revolving accounts. Furthermore, we have seen one balance increase lately that does not work with mortgages. It is paying the earnest money deposit on a contract with a credit card. A down payment source may not be a credit card advance. So always avoid this!
In conclusion, be boring during the mortgage process! So don’t increase balances, transfer unnecessary funds around, apply for new credit, or anything. At a minimum, there is more paperwork. Worse case is your loan doesn’t close! Check out a more in depth article on this topic, “You just killed your mortgage approval at the last hour! Solution, Be boring!“. It is our goal in all of our articles to provide readers the education necessary to make great real estate decisions.