Should I close my credit cards before applying for a home loan?

The decision to close credit cards before applying for a home loan is a nuanced one and requires careful consideration of various factors.

Acquiring a mortgage is a significant financial milestone for many Australian home buyers. The steps taken leading up to the application process can have far-reaching consequences. Whether you are a first-time buyer or a veteran in real estate pulling together cash for an investment, Aussies often grapple with whether to close credit cards before applying for a mortgage. This complex decision requires careful consideration, as it involves a delicate balance between managing credit history, credit card debt levels, and the impact on one’s mortgage eligibility.

Credit Scores in Mortgage Applications

Credit scores are a critical determinant that significantly influences a borrower’s eligibility and the terms they are offered. Understanding credit scores is paramount for individuals seeking to secure a mortgage, as it serves as a numerical reflection of their creditworthiness.

What is a Credit Score?

In Australia, credit scores typically range from 0 to 1,000 or 1 to 1,200, depending on the credit reporting agency. One of the primary roles of credit scores and affordability assessments in mortgage applications is to provide lenders with a quick and standardised measure of an applicant’s creditworthiness. Your creditworthiness or the likelihood you will make the loan repayments on time plays an important part in the mortgage application. Lenders perceive you as more risky when you have a lower credit score. Lenders rely on these lending criteria to gauge the level of risk associated with lending to a particular individual.

Credit scores serve as a key factor in determining whether a borrower qualifies for a mortgage. Lenders often establish minimum credit score requirements, and individuals with higher scores are generally viewed as lower-risk borrowers, increasing their likelihood of mortgage approval.

Credit scores and mortgage application

Credit cards contribute to building your credit score – it is a known fact; however, there are certain aspects of your credit card usage that may pose challenges when you apply for a mortgage. Even if you have a clean credit history and no bad credit, you need to be aware that merely possessing a credit card or applying for new credit cards can significantly influence your borrowing capacity. This is because many credit bureaus evaluate your credit rating based on your credit card limit rather than your current balance.

Credit history

When seeking a new home loan, the primary question on a lender’s mind is whether you have the ability to repay it. In order to address this question and instil confidence in your financial habits, lenders thoroughly examine factors such as your income, expenditures, debts, dependents, employment history, and obviously, your past borrowing and repayment behaviour, i.e., your credit history.

Credit limit

And there’s more – regardless of whether you utilise your credit card or consistently make monthly repayments, it will still influence the borrowing limit available to you. This is because what matters is your credit limit and the way you use it more than the outstanding debt or credit utilisation.

Nevertheless, a low credit score is not necessarily a lending death sentence, as the rejection of your home loan is not inevitable. While some banks may consider lending to individuals with a less-than-ideal credit score, it’s probable that they will impose a higher interest rate.

If your credit is lower than average, before applying for any kind of loan product, it is a good idea to take steps to repair your credit.

Credit utilisation ratio

Responsible credit card management, such as making timely payments and maintaining a low credit utilisation ratio, can positively impact your credit score and, consequently, your mortgage approval chances.

Debt-to-income ratio

Your debt-to-income ratio is assessed by comparing your monthly debt payments to your income. Credit card balances contribute to this ratio, and high balances may affect your ability to qualify for a larger loan amount. Responsible credit card use, coupled with a lower debt-to-income ratio, can strengthen your home loan application.

Interest rate

The credit score of an applicant plays a pivotal role in determining the interest rate assigned to their mortgage. Borrowers with good credit scores are typically rewarded with lower interest rates with a fixed rate, translating to lower overall borrowing costs. Conversely, lower credit scores may result in high-interest rates to offset perceived lending risks.

LVR and deposits

Beyond interest rates, credit scores can influence other loan terms, such as the loan-to-value ratio and the size of the deposit required. Individuals with higher credit scores may have access to more favourable loan terms, including

lower deposit requirements

Credit scores also play a role in the types of mortgage products available to borrowers. Individuals with higher credit scores may qualify for a broader range of mortgage options, including more competitive and flexible products.

Late payments and defaults

Any history of late payments or defaults on your credit card can have detrimental effects on your credit score. Lenders view such instances as red flags, potentially leading to higher interest rates or even rejection of your home loan application. Consistent, on-time payments on your credit card are essential to demonstrate financial responsibility.

Having multiple credit cards

Possessing multiple credit cards can be seen as an indicator that you are exceeding your financial means. The greater the number of cards you possess, the lender will infer a higher monthly credit card payment obligation on your part.

Disclaimer: Prepared by Bricklet. This information does not take your personal objectives, circumstances or needs into account. Always read the disclosure documents for products and services before deciding on a product or service, and consider seeking independent legal, financial, taxation or other advice for your unique circumstances.

“This offer provides a different option for those who haven’t yet saved a large deposit but are earning enough to meet the ongoing financial commitment of a home loan." 

Sean O'Malley
Group Executive AMP Bank

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