Mistakes to Avoid when Cleaning Up Your Credit for a Refinance
Are you in the process of refinancing a home? As you may have discovered, refinancing a home these days is much more complicated than it ever used to be. Lowered property values and tougher restrictions means that qualifying for a refinance is no longer a “given”.
According to our personal banker, the current approval for a refinance is running about 10% compared to an 80% approval rate less than a few years ago. The lower home values, lowered credit scores, and minimal savings all impact the ability to refinance. Credit card debt and how you manage those credit cards also factor into the equation.
How Your Credit Card Management Can Impact a Home Refinance
Since my husband and I knew we’d be refinancing at some point in 2010 or 2011, we’ve made a point of keeping our credit absolutely stellar. High interest card balances were shifted to low interest cards, unused cards were canceled, and store accounts were paid down to zero in anticipation of lowering our debt-to-loan ratio.
Unfortunately, what we thought was a smart financial move actually lowered our credit score instead. And because of the lower credit score, we ended up with a slightly higher interest rate than we would have liked plus had to bring money to the table to make the deal work. When it comes to refinancing a home, a lower credit score can mean a higher interest rate on the loan; as much as 1.5% higher depending on the bank.
So, What Did We Do Wrong? Just About Everything It Turns Out.
Mistake #1: Consolidated all our credit card and store account balances to two low interest cards.
While normally this is a smart financial move that lowers credit card interest and your monthly payment obligations, this maneuver can also lower your credit score. Lenders prefer seeing debt evenly scattered over several cards instead of high balances on two cards and zero balances on the rest.
How much is used of an available credit line is a big factor in determining a credit score. Our banker suggested that credit card balances should be no more than 25%-35% of the total credit line.
Mistake #2: Paid off store charge accounts.
Our reasoning behind paying off the store cards quickly was that it lowered our debt to loan ratio. According to our lender, a smarter strategy would have been to spread those extra payments evenly across the board instead of focusing on one card at a time. A healthy mixture of different credit types will actually improve a credit score .
Mistake #3: Canceled unused cards.
Another factor that determines a credit score is the length of credit history. Credit cards that you’ve held for long periods of time improve your credit score which is why canceling a long term card in good standing can also lower a credit score.
Mistake #4: Opened new accounts.
A few months before we applied for a new loan, we opened up a couple of new charge accounts to take advantage of some incredible discounts for new card holders. Unfortunately, opening these new accounts also lowered our credit score as well. Opening new accounts just prior to a refinance sends a red flag that a lender may be overextended.
How you manage your credit card debt can impact both how you qualify for a refinance, and the interest rate of your new home loan. Keeping your credit squeaky clean, avoiding new cards, making those payments on time, and not charging too much on any one credit card will go far in getting approved for a refinance with the lowest interest rates possible.