Friday, March 31, 2023

Does Credit Card Debt Affect Mortgage Refinancing

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Pay More Than The Minimum Deposit

Can I Refinance My Home To Pay Off Credit Card Debt?

If you can afford it, you should pay more than the minimum initial deposit for your property. This will definitely act in your favour and raise the chances of you being able to secure a mortgage.

For more information on what you can do to improve your chances, you can visit an independent debt charity such as StepChange or National Debtline.

How Does Credit Card Debt Affect Down Payments

As we mentioned earlier, your credit card debt affects your credit score, which may in turn affect the down payment you need to make when buying a home.

Many mortgages require a minimum down payment, which is determined as a percentage of the home price. Depending on the type of home loan you choose, you may need a higher down payment if your credit score is too low.

For example, an FHA loan requires a 3.5% down payment if your credit score is at least 580. That means a $200,000 home requires a $7,000 down payment.

However, with a lower credit score of 500-579, youd need to make a 10% down payment. For that same $200,000 house, youd need a $20,000 down payment. FHA loans may also require you to pay mortgage insurance, which would increase your monthly payments.

The upside is that paying more money upfront means you end up borrowing less. That can save you money on your monthly mortgage payments as well as the amount you spend on interest over time. Even if a loan type has a minimum required down payment, you can always pay more upfront to reduce how much you borrow.

When You Apply: Hard Credit Inquiries

Whenever you apply for credit, including a mortgage, the lender conducts a hard credit inquiry to see if you qualify for the product. The inquiry is recorded on your credit reports and may temporarily affect your credit scores.

New credit accounts for 10% of your FICO score. The credit-scoring company says one inquiry may lower your credit scores by five points, but multiple hard inquiries may have a larger impact.

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Can You Refinance To Pay Off Debt

Before refinancing a mortgage to pay off debt, you’ll need to be sure you have enough equity. If you end up owing more than 80% of your home’s value after you refi, you’ll have to buy mortgage insurance.

To avoid owing more than 80% of the home’s value, you’ll need to calculate your loan-to-value ratio. It’s simple: Divide your mortgage balance by the approximate value of your home.

/ = loan-to-value ratio

If you want to cash out some home equity to pay off debt, add the amount of debt youre paying off to the loan amount, like this:

+ / = cash-out refinance loan-to-value ratio

Heres an example: Lets say you owe $200,000 on a home worth approximately $300,000, and youd like to pay off $15,000 in debt. Your calculation would look like this:

/ $300,000 = 0.7167 or roughly 72%

Since your loan-to-value ratio is less than 80%, you can cash out enough equity to pay off your debt without having to pay for mortgage insurance.

» MORE:What home equity is and why it matters

Consider A Debt Management Plan

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There is no shame in asking for help. If you owe a lot in credit card debt and cant seem to keep up, consider. Nonprofit organizations can help you create a debt management plan and work with your creditors to create a financial plan to pay back your loans.

Typically the way a debt management plan works is that you deposit money with the credit counseling organization, and they use that to pay your creditors. There are usually fees for this service, which can include an ongoing monthly and set-up fee.

Using a debt management plan could be worth it if you dont trust yourself to make on-time payments and you want someone to negotiate lower rates and follow a set payment plan on your behalf. In many cases, these organizations can help you negotiate lower monthly payments or interest rates and pay off your debt within 36 to 60 months.

If you decide to go this route, be sure to thoroughly vet your options. Search for one that is accredited by the National Foundation for Credit Counseling . Sadly, there are some shady organizations out there, so be sure to research your options before committing. You should also be aware that debt management is different than debt settlement, which involves a for-profit company negotiating with your creditors and lenders for you to pay back less than you owe.

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How Might Debt Refinancing Affect Your Credit Score

Something to keep in mind when your goal is to pay down debt is that its a long game.

That being said, in the short term your credit score can decrease slightly when you apply for new credit and the lender looks at your credit report. During the formal application process, the lender will perform a hard inquiry into your credit report, which may result in a slight temporary drop of your credit score.

If youre comparing multiple lenders, and they offer prequalification, theyll do a soft inquiry into your credit report, which wont affect your credit score.

Building your credit or rebuilding it through refinancing credit card debt can be possible if you make on-time, regular payments on the new loan. Reducing your credit utilization can be another positive result of refinancing credit card debt. Both of these can potentially increase your credit score.

Its important not to overuse the credit cards you refinanced into a new loan, however, or you might accumulate even more debt than you started with.

How Your Mortgage Application May Change

When your credit score changes, the rate on your mortgage could change as well. A bump in your rate can make a big difference over the life of your loan.

Lets take a look at what a difference in one percentage point on a 30-year fixed rate could mean for your wallet.

A $300,000 mortgage loan at 3.00% APR for 30 years would have a monthly mortgage payment of $1,264.81. Youll pay $155,332.36 in interest during the life of the loan.

The same $3000,000 mortgage loan for 30 years at 4.00% APR would have a monthly mortgage payment of $1,432.25. Youll pay $215,608.52 in interest with this increased rate.

A percentage point difference in your rate is a difference of $60,276.16. In other words, its important to do everything you can to protect your credit score when you know youll be purchasing a home.

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Use The Debt Snowball Method

Best for: People with relatively small, low-interest debts

It might not be worth consolidating your debts if you have small balances that you can pay off within a year, or you dont qualify for a personal loan or credit card.

With the debt snowball method, you make the minimum payments on all of your debts every month, but you put any extra money toward your smallest debt first. Then, move in order from the next-smallest balance to the largest. You should gain momentum like a snowball rolling down a hill.

What Are Todays Refinance Rates

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Refinance rates are still at historic lows. But not all lenders offer the same rates. To find the best deal, youll need to shop around with at least 3-5 mortgage lenders.

The good news is, getting multiple refinance rate quotes wont hurt your credit score.

As long as you get all your quotes within a few weeks of one another, they count as a single inquiry on your credit report. So dont let credit worries stop you from shopping around and finding the best rate.

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Can You Consolidate Credit Card Debt Into Your Mortgage

Estimated reading time: 4 minutes

Quick answer: Absolutely you can. Its called a cash-out refinance and its a great option for some people. Heres what it boils down to: home loans typically have lower interest rates compared to credit cards, which typically have high interest rates. In order to take advantage of mortgage rates, cash-out refinances allow you to cash out equity in your home to pay off credit card debt and the amount thats cashed out becomes part of your mortgage. So, instead of paying a bunch of high-interest credit card debt, you would be paying one lower-interest home loan.

This could free up a lot of money each month depending on your debt and how your loan is structured. For the twelve-month period of June 2021 to May 2022, we saw our customers lower their monthly debt payments by $590 per month on average.* Heres more on how they work.

Modifying An Existing Home Loan

Modifying a loan may have less of an effect on your credit score, either way, than refinancing the debt with a new lender or loan. Thats because modification generally wont change your balance or the accounts opening date.

When you modify a loan with the same lender, you generally just get better terms than you have right now. For instance, if your credit score is significantly better than it was 10 years ago when you bought your home, you may be able to approach your lender to ask for a better interest rate.

This loan modification may affect your score slightly, since the lender will pull a credit report to check your creditworthiness. But the overall effect of this move will likely be slight and short-lived.

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Dont Refinance When A Big Purchase Is Coming Up

If youre getting ready to buy a home or apply for a loan for a new car, now is not the time to refinance. In fact, its not a good idea to make any big credit moves before either of these events.

Thats because even that small, temporary ding from credit inquiries and opening a new account could cause your lender to get cold feet. Its much better to wait until you close on the new loan, and then apply to refinance.

Dont Open More Loans Too Soon

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The more applications you complete, the more hard inquiries youâll see on your credit report. And itâs not restricted to refinanced home loans. If you apply for a credit card, a car loan or even a personal loan in the weeks leading up to refinancing, your credit score will likely go down.

If you want to complete a few applications with many different lenders, make sure you do within a few weeks of your first completed application. That way the hard inquiry only counts as one inquiry, not one inquiry for every application you complete.

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How Is My Personal Loan Rate Decided

As you shop for a low-interest loan or credit card, remember that banks are looking for reliable borrowers who make timely payments. Financial institutions will look at your credit score, income, payment history and, in some cases, cash reserves when deciding what APR to give you.

To get approved for any kind of credit product , you’ll first submit an application and agree to let the lender pull your . This helps lenders understand how much debt you owe, what your current monthly payments are and how much additional debt you have the capacity to take on.

Once you submit your application, you may be approved for a variety of loan options. Each will have a different length of time to pay the loan back and a different interest rate. Your interest rate will be decided based on your credit score, credit history and income, as well as other factors like the loan’s size and term. Generally, loans with longer terms have higher interest rates than loans you bay back over a shorter period of time.

How Refinancing Affects Your Credit Score

Refinancing might lower your credit score by just a few points, but thats inevitable when shopping for a new loan or credit account.

There are two reasons refinancing affects your FICO score:

  • Length of credit history FICO monitors the age of your oldest credit account and newest account, and averages out the age of the others. So think twice before opening or closing any account, especially credit cards youve had a long time. Closing your current mortgage may have little impact if its only been in existence a few years
  • Soft and hard inquiries for new credit When you check your own credit or a monitoring service does it on your behalf, thats a soft credit inquiry, meaning your score is unaffected. But when you apply for new credit, thats a hard credit inquiry and your score takes a small hit. FICO says for most borrowers, the hits likely to be less than five points. As long as you run all your accounts properly once the new ones in place, your score should be back to normal within a few months
  • Also note that Experian, one of the Big Three credit bureaus, says many credit scoring technologies will continue to consider the payment history on your old mortgage even after you close it.

    That can minimize the negative effects of closing your old loan. But be sure your current loan is in good standing when you refinance. More on that below.

    For most, refinancing should have few, if any, lasting effects on your credit score.

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    Cashing Out Equity To Pay Off Debt

    Can you use a cash-out refinance to pay off debt? You bet! In fact, a 2021 survey found that debt consolidation is the second most common reason for a cash-out refinance.

    Now could be an especially good time to cash-out home equity and pay off debts. Equity levels rose by nearly 30% between 2020 and 2021. And mortgage rates are still low.

    Qualified homeowners could substantially lower their debt payments and increase their monthly cash flow using this method.

    In this article

    Why Your Mortgage Application May Change

    Credit Cards [How are credit cards assessed when applying for a mortgage]

    Your credit score is an important piece to your mortgage application. Heres how a new credit card can impact your score.

    Average age of credit: Age of credit makes up 15% of your credit score. With a new line of credit, this factor may decrease your score.

    Hard inquiries: Credit inquiries affects your credit score by 10%. Your lender or credit card issuer will do a hard inquiry or hard pull of your credit score and history when you apply for a new loan or card. Hard pulls can cause a short-term dip in your score, but they typically fall off of your credit report after 18-24 months.

    Credit utilization makes up 30% of your score and looks at how close to your credit limit you are on all your lines of credit. For example, if you have a credit card with a $10,000 limit and have a $5,000 credit card balance at the end of the month, your credit utilization is 50%. For this reason, its important to consider how you are using credit cards during a mortgage application, not only opening a new card.

    If you open a new credit card, your overall credit limit would go up, which could be good for your credit score. To keep your credit score in a good spot, experts advise keeping this ratio under 30%.

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    How Can A Refinance Help You Consolidate Debt

    A refinance mortgage loan, whether it is a rate and term refinance or a cash-out refinance has the potential to save you money and help you consolidate unsecured debt. A cash-out refinance, specifically, can help you take a lump sum payment and pay off major debt like revolving credit card balances. Additionally, unlike a second mortgage or a personal loan, a cash-out refinance does not add an additional bill to your monthly expenses.

    Most lenders require that a homeowner have at least 20% of established equity in their home and have successfully completed a minimum of 6 months of mortgage payments. As you pay down your mortgage you build equity. The equity you establish in your home allows you to access liquid assets.

    If you complete a cash-out refinance, when you make your mortgage payment, essentially you will also be paying down your credit cards. Instead of balancing multiple cards with multiple due dates and aggressive interest rates, you have the ease of making one monthly payment at a lower and more affordable interest rate. The average American has four personal credit cards with varying interest rates. Mortgage interest rates are typically 3% – 5% compared to credit cards interest rates which can exceed 21%. As mortgage interest rates remain near record lows, as a homeowner not only could you consolidate your credit card and other major debt into one payment, but you could also save thousands on interest.

    What A Mortgage Affordability Calculation Looks Like In Real Numbers

    Heres an example to illustrate how credit card debt might affect a couples mortgage eligibility, using the GDS and TDS limits at two different interest rates. .

    If annual household income is $100,000, maximum housing costs should not exceed $32,000 annually according to the 32% GDS guideline. If we assume property taxes, heat and 50% of condo fees total $5,000 a year, that leaves up to $27,000 annually for mortgage carrying costs:

    $27,000 mortgage costs + $5,000 other housing expenses = $32,000 total housing costsGDS = $32,000 total housing costs / $100,000 gross income = 32%

    Based on their income, this couples mortgage payments cannot exceed $27,000 annually , even if they have no other debt. At five-year fixed rates of 1.75% and 3%, the maximum mortgage loan would be about $545,000 and $475,000, respectively.

    Now lets look at the couples other debts. Say they spend $4,200 annually in student loan payments, and $3,600 annually in minimum credit card payments on a $10,000 balance. Their TDS ratio works out to 39.8%:

    $27,000 mortgage costs + $5,000 other housing expenses + $7,800 debt service costs = $39,800 total debt loadTDS = $39,800 total debt load / $100,000 gross income = 39.8%

    Because their TDS is within the 40% guideline, their mortgage borrowing power is not affected. The most the lender will approve in mortgage carrying costs is still $27,000 annually , and the mortgage loan qualification amounts remain the same.

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