We’re going to be trying to get pre-approved for a new mortgage soon.
As a self-employed family, we need our credit score, and debt-to-income ratio to be as rock-solid as possible.
Therefore, for the next three months we’re using only our debit card to make purchases.
This stinks because we usually do all of our spending on our Chase Freedom credit card. The card pays at least 1% cash back on all our spending. So we stand to make over $100 each quarter.
That’s $100 we won’t be earning this year. But if it means getting a great mortgage rate then it’s worth it, right?
Why are we doing this?
Like I said, we need our credit score and debt ratio to be optimized. Ironically, using our credit cards like we do helps us to maintain a good score, but in this instance, reporting a big balance is hurting us. Let me explain.
How Big Credit Card Balances Are Reported
Financial institutions report your information to the credit bureaus in a variety of ways. I believe at their choosing. This is something out of our control. So even though we pay off our credit card balance in full each month, our latest period-ending balance is reported. Here’s more from creditcards.com on the issue:
Banks pass your account information, including balances and limits, along to the credit bureaus, which in turn list that information on your credit report. When you (or a lender) request to see your credit score, the current information on your report gets plugged into a credit scoring formula. The issue for heavy-charging — but otherwise responsible — cardholders is exactly when various lenders report information to the bureaus.
To anyone looking to lend us money, it appears as if we have a hefty amount of credit card debt. Remember, we do all of our spending (except our current mortgage payment) with our credit card, netting us close to $500 each year in rewards.
How This Affected Our Refinance
This whole thing came into play last Summer when we were refinancing our current place. Even after telling the lender how we paid the credit card off every month, and even showing them our statements, the lender asked us to close down the account completely so that we could complete the loan and meet the needed income-to-debt ratio.
I laughed at them and then realized they were serious. To avoid having to do this, we paid off our low-interest car loan. Then all was right in the underwriter’s eyes.
Now, there’s no more debt for us to eliminate. So this time around I’m not taking any chances. We’re stopping the credit card use a month before asking to be pre-approved for a mortgage. To be honest, I’m hoping we didn’t wait too late to start this, with reporting delays and all.
Additionally, (and I’m making an assumption here based on my understanding of credit utilization) our credit score is affected by this reported credit card balance. So, it’s just best to be safe and eliminate the revolving debt.
More Important Things to Do Before You Apply for a Mortgage
Other, might I add, more relevant, things we’re doing to improve our chances of getting a mortgage include: making sure it fits for our budget, saving up a big down payment, getting our current place under a rental agreement, and getting my small business finances and taxes in order.
Hopefully, we’ll overwhelm the lender in these areas and the “phantom” debt won’t be an issue like last time.
Update: Two readers have chimed in with potential solutions to my problem.
- I could talk with the credit card company and find out exactly when they report to the credit bureaus. Then simply start paying my bill off in full before that date each month.
- I could “prepay” my credit card usage (i.e. make a pre-payment to the credit card, forcing a positive balance).
In both situations, we can continue spending on the card like we normally would and still earn the points. You guys are smart. I’m so glad I posted about this. I’ll update you again once I try one of these methods.
Image by Uwe Hermann