Be wary of closing credit cards when applying for a mortgage
Tanisha Warner is the communications manager for Money Management International, where she manages educational content designed to teach consumers about personal finance topics. She writes "Credit Care," a weekly reader Q&A about debt issues, for CreditCards.com.
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Dear Credit Care,
I am holding a store credit card for a store that no longer has physical stores and purchases may be made only online. I want to close that credit card. Would that affect my credit score, as I start looking for a mortgage loan? Also, I hold another store credit card and am not using it much. Will that hurt my credit score if I am going to close that one, too? -- Rajesh
You are wise to consider how any changes to your credit profile might affect your credit score, particularly when shopping for a mortgage loan. Without knowing the particulars of your credit profile, it is difficult to know precisely how closing the accounts would affect your credit. I can paint the broad outlines, though, and let you know that closing the accounts probably means a slight, temporary drop in your credit score.
Let's look at the big picture first. Closing accounts could significantly lower your available credit. That would hurt your credit utilization rate -- how much debt you have compared to available credit -- and that's the second-most important factor that the credit scoring firm FICO uses in calculating your score. (Your payment history is the most important, by the way.)
Also, if you do not have any other revolving credit accounts, closing these two could negatively affect the area of your credit score that involves types of credit used. To achieve the best score, you need to have open, positive accounts that incorporate both revolving and installment terms.
My initial reaction is to tell you not to make any changes to your credit right now. It may be better to wait until you secure your mortgage. The reason is that a drop in your credit score of only a few points may move you into a lower bracket of scores which lenders use to qualify you for loans.
For example, if your credit score is currently 760 and closing one or both of your credit card accounts dropped your score by only five points to 755, it could mean the difference between a mortgage loan at 3.53 percent interest (for a scores of 760 and up) and a loan at 3.76 percent interest (for a scores ranging from 759 to 700). For a 30-year mortgage loan of $216,000, the higher interest rate could mean paying more than $10,000 more in interest payments for the life of the loan.
If you have not already done so, I would suggest that you acquire your credit reports from each of the three major credit bureaus -- Equifax, Experian and TransUnion -- as well as your FICO credit scores from Equifax and TransUnion. (You cannot buy a FICO score based on your Experian credit report, due to a dispute between the credit bureau and the credit scoring giant.) You will want to know what your potential mortgage lenders are viewing when they review your credit. Mortgage lenders will typically review your records from all three bureaus.
Next, determine what interest rate mortgage loan you should qualify for with the lowest of your three credit scores. You can find the average mortgage loan interest rates in your state based on your FICO credit score at http://www.myfico.com.
Depending on how good your score is, you may decide to put off securing a mortgage loan until you can improve your credit score and qualify for a lower mortgage loan interest rate. (For tips for improving your score, check out "8 legit ways to raise your credit score.) In addition, the FICO scores that you acquire from the credit bureaus should include specific tips for you to improve your score.
You may also want to acquire your VantageScore from the three major credit bureaus. This credit score was developed by Equifax, Experian and TransUnion and is being used by more and more lenders. When comparing mortgage loan offers from lenders, be sure to ask which credit score the lender uses in making lending decisions. Also, lenders are now required by the Fair and Accurate Credit Transactions Act to notify you if your credit score adversely affected the interest rate you were offered.
Handle your credit with care!
Tanisha Warner is the communications manager for Money Management International, the largest nonprofit, full-service credit counseling agency in the United States. She manages educational content designed to teach consumers about personal finance topics. You can find more money management advice on Blogging for Change and MMI's Facebook page.
Credit Care answers a question about a debt or credit issue from a CreditCards.com reader each week.
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Published: January 16, 2012