Acquiring a mortgage is a significant financial milestone for many Australian home buyers. The steps taken leading up to the application process can have far-reaching consequences. Australians frequently debate whether to cancel credit cards before submitting an application for a mortgage, regardless of whether they are seasoned real estate investors or first-time buyers needing to save up money for an investment. This is a complicated choice that needs to be carefully thought through because it involves striking a careful balance between credit card debt, credit history, and how these factors affect one’s eligibility for a mortgage.
Credit scores are a critical determinant that significantly influences a borrowers eligibility and the terms they are offered. For those looking to obtain a mortgage, understanding credit scores is essential because they are a numerical representation of their creditworthiness.
Closing credit cards prior to submitting an application for a home loan is a complex decision that needs to be carefully thought out.
Your credit score may be impacted by closing a credit card because you may have less available credit overall. Your credit score is heavily influenced by your credit utilisation ratio, which is the ratio of your credit card balances to credit limits. Closing a card may increase this ratio, potentially impacting your creditworthiness.
Closing older credit card accounts can shorten your credit history, potentially having a negative impact. A longer credit history is generally viewed favourably by lenders.
Closing your credit card account lowers your credit available, which could result in a rise in your credit utilisation ratio. Consequently, this may have an adverse impact on your credit score. Borrowers with high credit utilisation ratios are seen by lenders as possible risks because it suggests that a sizeable amount of their available credit is being used.
The Impact of Closing Credit Cards on Your Credit Score
Many people wonder if they should close their credit cards before applying for a mortgage. While it might seem like a good idea to reduce your debt closing credit card accounts can actually have a negative impact on your credit score.
Here’s why:
- Credit utilization ratio: This ratio measures the amount of credit you’re using compared to your total available credit. Closing a credit card account reduces your available credit, which can increase your credit utilization ratio. A high credit utilization ratio can hurt your credit score.
- Credit history length: Your credit history length is the amount of time you’ve had credit accounts open. Closing a credit card account shortens your credit history, which can also hurt your credit score.
- Number of open accounts: The number of open accounts you have is another factor that affects your credit score. Closing a credit card account reduces the number of open accounts you have, which can also hurt your credit score.
Is Closing Your Credit Card Account a Good Idea?
In most cases, it’s not a good idea to close your credit card account before applying for a mortgage. Paying off your credit card debt is a much better option. You can keep the account open without using it, which will help your credit score in the long run.
However, there are a few exceptions to this rule. If you have a credit card with a high balance or a high interest rate, it might make sense to close it. You should also consider closing any credit card accounts that you don’t use anymore.
Tips for Improving Your Credit Score Before Applying for a Mortgage
If you’re planning to apply for a mortgage, there are a few things you can do to improve your credit score:
- Pay off your credit card debt. This is the most important thing you can do to improve your credit score.
- Keep your credit utilization ratio low. Aim to keep your credit utilization ratio below 30%.
- Don’t open any new credit accounts. Opening new credit accounts can hurt your credit score in the short term.
- Become an authorized user on a credit card with good credit history. This can help you improve your credit score without having to open a new account.
- Dispute any errors on your credit report. Errors on your credit report can hurt your credit score.
Closing your credit card account before applying for a mortgage can hurt your credit score. In most cases, it’s better to pay off your credit card debt and keep the account open. However, there are a few exceptions to this rule. If you have a credit card with a high balance or a high interest rate, it might make sense to close it. You should also consider closing any credit card accounts that you don’t use anymore.
If you’re planning to apply for a mortgage, there are a few things you can do to improve your credit score. Pay off your credit card debt, keep your credit utilization ratio low, don’t open any new credit accounts, become an authorized user on a credit card with good credit history, and dispute any errors on your credit report.
Additional Resources
- CreditCards.com: Should I pay off or close my credit card to get a better mortgage?
- Chris Lee’s LinkedIn article: Getting a Mortgage? Should I Cancel my Credit Cards?
Frequently Asked Questions
- Will closing my credit card account hurt my credit score?
Yes, closing your credit card account can hurt your credit score by increasing your credit utilization ratio and shortening your credit history.
- Should I close my credit card account if I have a high balance?
It depends. If you can’t afford to pay off the balance quickly, it might make sense to close the account. However, if you can pay off the balance within a few months, it’s probably better to keep the account open.
- Should I close my credit card account if I don’t use it anymore?
Yes, you should close any credit card accounts that you don’t use anymore. This will help to improve your credit score.
- How can I improve my credit score before applying for a mortgage?
Pay off your credit card debt, keep your credit utilization ratio low, don’t open any new credit accounts, become an authorized user on a credit card with good credit history, and dispute any errors on your credit report.
Be a responsible credit card holder
Effectively utilising your credit card can indeed enhance your credit score, provided it is done judiciously. Using your credit card for purchases and paying off the balance quickly creates a favorable borrowing and repayment history that prospective lenders can evaluate.
Lower your credit limit
Another strategic move is to approach your bank and request a reduction in your credit limit. Aim to minimise your limit as much as possible. This two-fold action gives you more control over how you use credit cards and increases your chances of getting approved for a home or auto loan.