Does a Line of Credit Affect Mortgage Approval?
Having a line of credit does affect your mortgage approval. All types of credit and debt negatively impact your mortgage approval, either by reducing the amount you’re approved for or by preventing you from being approved at all.
Key Takeaways
A line of credit will affect your mortgage approval.
Your credit score, income, and debt level are important factors in mortgage approval.
To improve your chances of getting approved, consider paying down debt, improving your credit score, lengthening loan terms, and avoiding new credit/loan applications.
Understanding Lines of Credit
A line of credit is a popular option for borrowing money. It is a flexible type of loan that allows you to borrow money up to a pre-set limit. You can use as much or as little of the funds as you need, and you only pay interest on the amount you borrow.
Lines of credit are often used for home renovations, debt consolidation, or unexpected expenses. However, it's important to use them responsibly and not borrow more than you can afford to repay.
Any amount on your line of credit will impact your debt and credit score, which both impact your mortgage approval.
How a Line of Credit (and All Credit) Affects Mortgage Approval
Debt-to-Income Ratio
Having a balance on your line of credit affects your debt-to-income ratio, which is the amount of debt you have compared to your income. This ratio is an important factor that lenders consider when approving a mortgage.
For revolving credit (which includes lines of credit and credit cards), mortgage companies assume you are paying 3% of your balance per month when calculating GDS and TDS ratios. For example, if you owe $10,000 on a line of credit, that means a $300 per month payment needs to be debt serviced when calculating your borrowing ratios.
Mortgage lenders will consider that payment when determining your mortgage amount, as every dollar you put towards existing debt means less money for you to use on your mortgage.
The rule of thumb is that for every $100 per month of credit repayments, your mortgage eligibility is reduced by around $10,000.
Credit Score
Credit score also impacts your eligibility for a mortgage. A credit score shows how reliably you’ve repaid credit in the past.
If you have a history of missed or late payments on your line of credit, this can negatively impact your credit score. A bad credit score can make getting approved for a mortgage harder or result in higher interest rates.
How to Improve Mortgage Approval Chances if You Have a Line of Credit
Reducing Debt
Reducing your debt is one of the best ways you can improve your mortgage approval. If possible, it’s best to pay off your debt in full.
But even if you can’t eliminate your debts completely, you can still improve your chances of mortgage approval by:
Paying off high-interest debt first: Focus on paying off debt with the highest interest rates first, such as credit card debt.
Consolidate debt: Combine your debt into a single loan with a lower interest rate. This can make it easier to manage your debt and reduce your monthly payments.
Avoid taking on new credit: Don’t take on new debt, such as a line of credit or car loan, while you're applying for a mortgage.
Increase Loan Length
The trick to increasing your mortgage eligibility is to make sure your debt repayments are spread over the greatest number of years. If your loan term is longer, that means your obligated or minimum monthly payments are lower, which is what mortgage lenders will be looking at.
For example, if you need to take out a car loan before your mortgage, choose the 7-year loan term over a 5-year loan term. If it takes you the full 7 years to play off the loan, you will pay more interest on the loan, but it will increase your chances of mortgage approval.
Most car loans and consolidation loans allow for pre-payments without penalty. Even if you take that longer loan term, you can make prepayments (at your option but not obligation), and pay off the debts earlier.
Improving Credit Score
A higher credit score generally indicates that you're a lower-risk borrower, which can improve your chances of approval.
To improve your credit score, consider taking these steps:
Pay bills on time: Late payments can have a negative impact on your credit score. Make sure you pay your bills on time, every time.
Keep credit utilization low: Keep your credit utilization ratio below 30%. This means that you're using less than 30% of your credit limit.
Check your credit report regularly: Make sure that your credit report is accurate and up-to-date. If you notice any errors, contact the credit bureau to have them corrected.
How Will Your Line of Credit Affect Your Mortgage?
It's important to note that lenders use different criteria when evaluating mortgage applications, and the impact of a line of credit on your mortgage approval process may vary depending on the lender.
It's essential to talk to your mortgage broker and understand each lender’s specific requirements before applying for a mortgage.
Your credit history, income, and other debt can also greatly affect your mortgage approval, so a line of credit isn’t the only thing to consider. For the best advice tailored to your situation, contact the mortgage brokers at Spire Mortgage.
