Monday, October 13, 2008

Credit Cards and Home Purchases

With credit cards so prevalent in U.S. consumers' wallets nowadays, there is a great likelihood that many potential home buyers have some plastic in their pockets. When preparing for a home purchase, consumers should consider the complicated role a credit card can play in that process.

Having a credit card can work in your favor when you go to buy a house. This is largely due to the way that a consistent history of timely credit card payments can help you build a strong credit history and a high credit score. That can be a big advantage for a consumer in the market for a home. A positive credit history can help a consumer secure a loan more easily.

However, on the flip side, negative items on your credit history and a lower credit score could limit your options when buying a home, even if you are currently making all your credit card payments on time. Indications of financial stress on your credit report that could ding your score include new credit card issuances and high utilization ratios, which measure the ratio of credit card balances to credit limits. To avoid problems as you get ready to buy your house, get your utilization below 50% and avoid applying for additional credit cards.

Meanwhile, your credit card can impact the ability to qualify for the loan you are seeking because the required payments are added to the payments associated with the mortgage in determining how much you can afford. What is known as the "total expense ratio" is calculated by lenders and used in qualifying borrowers is the sum of the mortgage payment, property taxes, homeowners' insurance premium, and other debt service, including credit cards, all divided by the borrower's gross income. But if you are able to keep your total debt service payments under 8% of your gross income, it will not restrict the amount you can borrow.

In order to buy a house, you will need some cash for down payment and settlement costs. Usually, the larger the down payment the lower the cost of the mortgage. However, the relationship is tiered, not smooth. For example, if you from nothing down to 3% down, the cost of the mortgage will decline, but if you go from 3% to 4%, it won't. While there are exceptions, the major tier levels are 0%, 3%, 5%, 10%, 15%, and 20%.

In conclusion, credit card users looking to buy a home should make sure their card utilization ratios are below 50%, their total debt service payments are under 8% of their gross income, and their target down payment is in hand.

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