Getting a Home Loan When You Have Credit Card Debt

Yes, you can get a home loan with credit card debt, but lenders will look closely at how much you owe and whether you're paying it on time

Mortgage lenders don't require you to have zero credit card debt before they'll consider your application. What they care about is your debt-to-income ratio — the percentage of your monthly income that goes toward all your debts combined. If your credit card payments are eating up too much of your paycheck, a lender may deny you or offer you a smaller loan than you hoped for.

The other factor lenders examine is your payment history. If you're carrying credit card balances but paying them on time, that's far better than carrying balances and missing payments. Late payments, high balances relative to your credit limits, and accounts in collections will all make it harder to get approved for a mortgage.

Key Takeaways

• Most mortgage lenders allow you to carry credit card debt as long as your total monthly debt payments don't exceed 43 percent of your gross monthly income.
• Paying down credit card balances before you apply for a mortgage can lower your debt-to-income ratio and improve your chances of approval.
• Late payments on credit cards within the past two years will hurt your mortgage application more than older late payments.
• A higher credit score (typically 620 or above) makes approval more likely, and paying down credit card debt is one of the fastest ways to raise your score.

How lenders calculate your debt-to-income ratio

Your debt-to-income ratio is the total of all your monthly debt payments divided by your gross monthly income (before taxes). Most conventional mortgage lenders want this number to be 43 percent or lower, though some will go as high as 50 percent if you have a strong credit history and a large down payment.

Here's what counts toward that ratio: your car payment, student loans, personal loans, credit card minimum payments, child support, and the mortgage payment itself. The mortgage payment is estimated based on the loan amount you're seeking, so a larger loan request means a higher ratio. Credit card debt counts as whatever your minimum payment is each month, not the full balance you owe.

If you earn $5,000 per month and already have a car payment of $400, student loans of $200, and credit card minimum payments of $150, your existing debt payments total $750. That's 15 percent of your income before the mortgage. A lender might approve you for a mortgage payment of up to $2,150 per month (43 percent of $5,000 minus your existing $750), depending on your credit and down payment.

Why paying down credit cards before applying helps

Reducing your credit card balances before you apply for a mortgage does two things: it lowers your monthly minimum payments (which improves your debt-to-income ratio) and it raises your credit score. Both matter to lenders.

When you pay down a credit card balance, your credit utilization ratio — the percentage of your available credit you're actually using — drops. If you have a $5,000 credit limit and a $4,500 balance, you're using 90 percent of your available credit. Pay it down to $1,500, and you're using only 30 percent. Credit scoring models treat high utilization as a sign of financial stress, so lowering it can raise your score by 20 to 50 points or more, depending on how much you pay down.

Even if you can't pay off the cards entirely, reducing balances by 25 to 50 percent before you apply can make a real difference. Wait at least one or two billing cycles after you pay down the balance before you apply for the mortgage, so the lower balance shows up on your credit report.

What credit score you'll need for mortgage approval

Most conventional mortgage lenders require a credit score of at least 620, though many prefer 640 or higher. FHA loans (backed by the Federal Housing Administration) may accept scores as low as 580, and some lenders will go lower if you have other strong factors like a large down payment or a co-borrower with excellent credit.

Credit card debt and payment history make up a large part of your credit score. Late payments hurt more than high balances, and recent late payments hurt more than old ones. A payment that's 30 days late from six months ago will affect your score less than a payment that's 30 days late from last month. If you have recent late payments on credit cards, waiting a few months and building a record of on-time payments will help more than paying down the balance alone.

You can check your credit score for free through AnnualCreditReport.com, which is the only site authorized by the federal government to provide free credit reports. Many credit card issuers also show your score for free in your online account.

Timing: when to pay down debt before applying

The ideal timeline is to start paying down credit card debt three to six months before you plan to apply for a mortgage. This gives you time to see your credit score rise and your balances drop on your credit report, which is what lenders will actually see.

When you make a payment on a credit card, it doesn't always show up on your credit report right away. Most card issuers report to the credit bureaus once a month, usually around your statement closing date. If you pay down a balance mid-month, it may not appear on your credit report until the next month's statement closes. That's why waiting a billing cycle or two after you pay down balances gives you the best result.

If you're in a hurry to apply, you can still do it with credit card debt. Just know that your debt-to-income ratio will be higher, which may mean a smaller loan or a higher interest rate. Some lenders will also ask you to pay off certain credit cards entirely before closing on the mortgage, especially if the balances are high relative to your income.

What happens if your debt-to-income ratio is too high

If your debt-to-income ratio exceeds the lender's limit, you have a few options. The most straightforward is to pay down credit card balances before you apply, which lowers your monthly payments and improves your ratio. Another option is to increase your income — if you have a job offer or a side income source you can document, that will raise your denominator and lower your ratio.

You can also look for a co-borrower with income and good credit, such as a spouse or family member. Their income gets added to yours, which lowers the overall ratio. Some lenders will also consider a larger down payment as a reason to approve you despite a higher ratio, because it means you're borrowing less money and taking on less risk.

If none of those options work, you may need to wait a few months while you pay down debt and build your credit history. A few months of on-time payments and lower balances can make the difference between a denial and an approval.

How credit card debt affects your interest rate

Even if you're approved for a mortgage, credit card debt can cost you money in the form of a higher interest rate. Lenders use your credit score and your debt-to-income ratio to set your rate. A lower credit score or a higher ratio typically means a higher rate.

The difference between a 6.5 percent rate and a 7 percent rate on a $300,000 mortgage is roughly $150 per month, or $1,800 per year. Over a 30-year loan, that half-percent difference adds up to tens of thousands of dollars. Paying down credit card debt before you apply can lower your rate by negotiating a better credit profile, which saves you money over the life of the loan.

Frequently Asked Questions

Will a mortgage lender ask me to pay off my credit cards before closing?

Some lenders will, especially if your balances are very high or your debt-to-income ratio is close to their limit. They may require you to pay off specific cards or reduce balances to a certain level. This is more common with FHA loans than conventional loans. Ask your lender upfront what their policy is.

Does opening a new credit card hurt my chances of getting a mortgage?

Yes. Opening a new card lowers your average account age and creates a hard inquiry on your credit report, both of which can lower your score by a few points. It also adds a new monthly payment to your debt-to-income ratio. Avoid opening new credit accounts for at least three to six months before you apply for a mortgage.

What if I have credit card debt in collections?

A debt in collections will make mortgage approval much harder. Most lenders want to see either a payment plan in place or the debt paid off entirely. If you have a collection account, contact the creditor or collection agency to negotiate a settlement or payment plan before you apply for a mortgage. Getting it resolved will improve your credit score and your chances of approval.

Can I use a balance transfer to lower my credit card debt before applying for a mortgage?

A balance transfer moves your debt from one card to another, usually at a lower interest rate for a promotional period. It doesn't reduce the amount you owe, so it won't improve your debt-to-income ratio. However, if the new card has a higher credit limit, it may lower your credit utilization ratio and raise your credit score slightly. The hard inquiry from applying for the new card will temporarily lower your score, so do this well before you apply for a mortgage.

How long does it take for paying down credit card debt to show up on my credit report?

Most credit card issuers report to the credit bureaus once a month, usually around your statement closing date. If you pay down a balance, it should appear on your credit report within 30 to 45 days. Your credit score may take a few weeks longer to update after the new balance is reported.