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Today, TPG Senior Points & Miles Correspondent Jason Steele looks at how the pursuit of travel rewards can impact your credit score, and ultimately your mortgage and other loan applications.
Part of the bedrock of award travel is learning to take advantage of credit card sign-up bonuses. However, if you anticipate applying for a home mortgage or refinance, then you might be concerned about how your credit card usage could affect this process.
I recently had a chance to discuss this issue with mortgage loan officer Scott Wynn of The Wynn Team at Citywide Home Loans in Denver. Scott has been in this business for 13 years, and it was interesting to hear his perspective as a credit card and mortgage industry expert. In this post, I want to share his insights, and examine the mingling of credit card and other loan applications for anyone looking to bolster their points and miles balances by opening new accounts.
How the mortgage process works
To decide what to do with your credit cards before you apply for a mortgage, it helps to understand the process of securing a home loan, which is different from any other loan you’ll apply for.
The first thing Scott explained to me is that there are three factors lenders will consider about your personal finances when determining your qualifications: your down payment, your monthly income (minus any existing debts), and your credit score. The second and third factors are the ones that can be impacted by your credit card usage.
When you first speak with a mortgage broker, you’ll give him or her permission to pull your credit histories and FICO credit scores from all three major consumer credit bureaus. While these inquiries count as a “hard pull,” the FICO scoring model doesn’t count additional inquiries for home loans made within 14 days. Brokers pull from all three bureaus because the industry standard is to judge applicants based on the middle of the three scores (or the lower of two), in order to account for any differences in the data collected.
Next, your real estate agent might ask for a pre-qualification or a pre-approval from your mortgage broker. A pre-qualification is merely the broker’s opinion of your ability to qualify based on the information that you have supplied, while a pre-approval generally requires documents to be collected such as pay stubs, bank statements, and tax returns. This additional level of verification can add substantial weight to a home contract that a pre-qualification does not.
Your mortgage broker will then help select the best lender for your needs, and you’ll be asked to submit a formal loan application. Finally, about a week before you close on your loan, your credit will be checked a final time (which is a soft pull), and your employment will be re-verified.
How your credit card accounts shape your credit score
Credit cards can help your credit score by adding to your overall credit history, so long as you pay your bills on time and carry little debt. Your payment history and the amounts you owe comprise 35% and 30% of your credit score, respectively, making them by far the two most important factors. In addition, 15% of your score is focused on the length of your credit history, so keeping a few credit card accounts open for many years will help.
The remaining 20% is divided equally among the types of credit used and the new credit lines opened. Having credit card accounts open and in good standing will help, although applying for several new credit cards in a short period of time will hurt. Thankfully the drop in your credit score will be small and temporary, since this factor is the least important. For more information, see my post on How Card Applications Affect Your Credit Score.
Your credit score and your mortgage application
One of the big misconceptions about credit scores is that having a higher score will necessarily lead to lower rates. To qualify for the best mortgage rates available, you need to have a credit score of 740 and above, but in nearly all cases, having a score of 760, 780, 800, or higher won’t make the slightest difference. (Scott pointed out that he has seen some rare exceptions in the past when a lender offered a specific program that required higher scores, typically for very high value loans).
Let’s say that you pay all of your bills on time and have no substantial debts other than a modest credit card statement balance, which you pay in full each month. The chances are that you’ll have a credit score in the high 700s. If you decide to apply for a new credit card, your score may drop a few points, but so long as it remains comfortably above 740, you won’t hurt your chances to qualify for the best mortgage rates.
Problems that credit cards can create with the mortgage application process
One of the problems mortgage applicants encounter comes from using credit cards heavily (even while avoiding interest by paying statement balances in full each month), which is how many award travel enthusiasts typically behave.
As cardholders see it, they have no debt, as they never carry a balance and never pay interest. From the perspective of card issuers and lenders, however, the balance that appears on each month’s statement is the amount of debt that is reported to the credit bureaus. As Scott explained to me, your credit report and credit score are just a snapshot in time, yet lenders will see the minimum payment listed as a more or less a permanent debt obligation, regardless of whether you pay it in full a moment later.
That means the moment when your statement closes is critical to your credit score, although some card issuers may report balances more frequently than once a month. So if you’ve paid your balance, but it hasn’t been reported, then your credit report will still show the higher balance. Unfortunately, lenders will then see a greater amount of debt in your name, which impacts how much they will let you borrow. Knowing this, you can choose to pay balances in full before your statements close. That way, card issuers will report $0 balances, and your borrowing ability will not be impaired by the appearance of debt.
Another problem credit card users can face comes from applying for a new credit card (or any other loan) after having been pre-approved for a mortgage, and especially after having submitted a formal mortgage loan application. In fact, Scott advises all of his clients to do the following after they have received pre-qualifications:
- Do not use credit cards excessively.
- Do not let current accounts fall behind.
- Do not co-sign for anyone on a new account or loan.
- Do not give permission to anyone to run your credit (by applying for new credit accounts).
His rationale is that lenders conflate new inquiries with new credit applications, which changes your qualifications for the loan. Furthermore, the impact of these negative items can be much greater for non-homeowners and people with a limited credit history.
My advice to travel rewards enthusiasts
The real estate market is hot in many parts of the country, and mortgage rates are low, so a lot of readers may be considering moving or refinancing property. If that describes you, then you should speak with a mortgage broker who can quickly check your credit. Do this as early as possible to see where you stand and give yourself the opportunity to correct any mistakes.
If your score is close to 740, you should consider every option to hit that mark and stay above it, which means “fasting” from new credit card applications until the process is over. In addition, those who are looking to stretch their borrowing ability to the limit should be constantly paying their credit card balances off (even before statements arrive) to minimize the impact that debt has on their credit reports.
If you already have a very high credit score (by which I mean those in the upper 700s or above), there’s no need to change your behaviors. So long as you follow Scott’s advice from pre-qualification to closing, which should only be a few weeks in most cases, then you don’t have to use every trick possible to add a few points to an already excellent score.
Most fans of travel rewards that I know have become very savvy credit card users, but applying for home mortgage is a special circumstance that temporarily demands a new set of rules. By understanding the process and taking necessary precautions during this period, you can get the best mortgage rates possible, and continue your pursuit of award travel right after you close on your loan.
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