How your credit score affects your mortgage application

Q: Which is more important, credit utilization or credit-to-income ratio?  Right now I earn $60,000 per year and have access to three credit cards with a combined limit of $20,000. I have no other loans or debts and my current credit score (based on a FICO calculator) is about 720. I ask, because I’m starting to look at buying a house, and want to know what lenders consider as a more important ratio? Also, is it possible to better my credit score by reducing my credit utilization (which I would do by cancelling one credit card or asking for a lower limit)?

— House hunter, Halifax, N.S.

Answer from Robert McLister, mortgage planner with Ratespy: A strong credit profile and reasonable debt ratio are equally important if you want the best mortgage rates and terms.

Let’s start with credit first. People tend to overly focus on the credit score. It’s important, yes, but lenders don’t stop there. They scrutinize your payment history, unpaid debts, total debt load, number of open debts and age of accounts, to name just a few. For the best mortgage options, aim for a score above 700. If your score dips below 680, if starts getting harder to qualify for the best rates and terms.

For folks with revolving debt, cancelling credit cards or reducing credit limits can actually lower their credit score. That’s because it increases one’s credit utilization (i.e., credit used divided by credit available), which has a heavy weighting in your credit score.

Cancelling cards isn’t great either. It reduces the average age of your accounts, and the credit bureaus prefer to see long-established accounts. If you have no debt, then credit utilization is not something I’d worry about.

As for debt ratios, here’s a rule of thumb. As long as: 1) your monthly obligations are less than 39% of your monthly gross income, 2) you’re buying a marketable property, 3) your credit is strong and well established and 4) your income is stable and provable, then you’ll typically qualify just fine.

Note: “Monthly obligations” refers to your monthly debt payments, property taxes, condo fees (lenders account for ½ of condo fees in your debt ratios) and heating cost.

Robert McLister is a mortgage planner at intelliMortgage and founder of RateSpy.

Answer from Walter Melanson, lead analyst at PropertyGuys.com: My friend and PropertyGuys.com Mortgage Principal Broker, Sarah Albert, tells us that lenders look at many factors when they consider an application for approval. They review your credit scores, the property that you are looking to purchase and your source of down payment just to name a few. It is not necessarily whether one is more important than the other, as it is dependent on all factors considered.

Your credit score is generated based on multiple variables–including your credit utilization. If you are someone who carries a balance on your credit cards month to month, in order to positively effect your credit score you would want to be at a maximum of 75% credit utilization. If you use your credit cards and pay them off each month then this is considered more ideal as you have no additional debt to consider when reviewing your application for a mortgage. Whether your limit is $20k or $10k, it doesn’t matter if you are paying off the balance each month, which means that the limits are not as important. The limits become important when you are carrying a balance, as this impacts your debt-to-income ratio. This determines if you are able to afford the purchase. In the eyes of the lender, the debt-to-income ratio is extremely important. The lender wants to know that you make enough money each month to cover your bills and expenses. Of course, the above ratios and limits are only guidelines. Still, to keep your credit score in a healthy place, consider four factors:

Pay your bills on time;

2. Keep you credit utilization under 75%;

3. Have a mix of loans and credit cards if possible;

4. Limit the amount of credit inquires you have. If you don’t need it, don’t apply for it!

Walter Melanson is the co-founder and lead analyst at PropertyGuys.com, Canada’s largest private sale franchise network. A background in finance, economics and technology, Walter’s true passion lies in building a more modern approach to buying and selling real estate.

Answer from Nawar Naji, mortgage planner with Verico: The Mortgage Wellness Group: Your credit score will greatly impact your mortgage rates, so good credit utilization is key to improving your credit score.

For instance, if you have a credit card with a $10,000 limit, you want to keep what you borrow on that credit card to less than 60% of that limit, or no more than $6,000, at any one time. If you lower your credit card limit to $5,000, you end up increasing your credit utilization and this has a negative impact on your credit score.

So, the key to a good credit score is to use two to three credit vehicles—either loans or credit cards. This helps build up your credit history (lenders want to see 2+ years of history). But don’t extend your credit utilization (the amount of credit you use) on any one of your credit vehicles. This means not borrowing more than 60% on each line of credit, loan or credit card.

Nawar Naji is a licensed mortgage broker with Verico: The Mortgage Wellness Group in Toronto, Ontario. He has been brokering since 2007, helping clients finance homes and investment properties.