Myth: Too much available credit hurts home loan
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Dear Speaking of Credit,
I have a lot of credit cards -- about 10 when you count them all -- and don't carry any balances. I just like getting discounts and rewards. I would like to buy a house in the near future, and the mortgage broker I spoke to said he expects that to get the best rate, I should close several of the cards because that will increase my "mortgage credit score." Having too much available credit counts against you, he said, because it means you could run up debt. Is there a separate mortgage credit score, and does it take points off for having a lot of available credit? In short, do I have too many credit cards? -- Smitty
Good for you, paying off your cards each month and taking advantage of their discount and reward programs! One of the good things about already managing your credit so well is that you don't really need to take any further advice -- either from me or any mortgage brokers. But since you wrote, I'll give you my two cents.
Whether you realize it or not, by simply continuing to pay your balance off each month, you're probably already achieving a credit score that will qualify for a mortgage at the best rates. I say that because 65 percent of your score consists of how you pay and how much you owe. And with the other 35 percent of your score looking at length of credit history, new account openings and mix of credit, just by keeping new account openings to a bare minimum and leaving every one of those 10 credit card accounts open, your score can remain a good one.
But wait, did I just recommend leaving those cards open, despite the mortgage broker's advice to close several of them as a way to raise your credit score? Yes, and here's why.
Prior to about 20 years ago when credit scoring began to revolutionize the way mortgages are made, the conventional wisdom among mortgage lenders and brokers held that if a borrower has access to too much available credit, for many, the temptation to take advantage of it could be too great to resist. It was felt that eventually these borrowers would be so deeply in debt that their monthly mortgage payments would fall behind and the lender would have to foreclose on their homes.
And the solution? Close cards to reduce their amount of available credit.
It wasn't until the late 1980s when credit score developer Fair Isaac Corporation (FICO) began to study the credit files of millions of consumers. It was revealed that this and some other common assumptions about what makes a potential borrower more or less likely to get into financial trouble began to change according to how consumers actually behave financially.
After closely examining the data, not only did FICO find no evidence that "too much" available credit made an otherwise responsible borrower less creditworthy, they discovered that consumers like you with a history of utilizing only a small portion of their available credit and making all payments on time -- regardless of how much credit was made available to them -- turned out to be excellent credit risks and worthy of high scores.
The research also confirmed that long-held cards in good standing, which, when open, are more likely to remain on a credit report indefinitely, indicate greater financial stability and lower credit risk. As a result, keeping cards open, which simply requires some occasional activity, can help contribute to a long and healthy credit history.
Unfortunately, many mortgage lenders and brokers, like the one with whom you spoke, are either unaware of the facts or simply refuse to let go of the myth that, not only will too much available credit increase the likelihood of getting into debt over your head, but also that it will hurt your credit score and your ability to qualify for a mortgage.
Now, for some answers to your questions:
Q: Is there a separate mortgage credit score, and does it take points off for having a lot of available credit?
A: While FICO and other scoring companies have introduced various versions of "mortgage-specific" credit scores over the past few years, none have been widely adopted by mortgage lenders, Fannie Mae or Freddie Mac. The FICO "broad based" credit bureau risk scores used by most mortgage companies rely on the same scoring formulas used predominantly by banks and credit unions in credit card, auto financing, student loan and other kinds of consumer lending. Once again, the scores not only don't penalize you for how much available credit you have, but higher amounts of available credit in proportion to card balances tend to produce higher scores through lower credit utilization (balance/limit ratio).
Q: In short, do I have too many credit cards?
A: The number of cards you hold can be a factor in your score, though to only a minor degree. But it's not a number you can do much about once cards have been established, since the score doesn't take into consideration whether the cards are open or closed -- only that the cards appear on your credit report. So, closing a card won't reduce your number of cards in the eyes of the score -- closed cards and the positive payment activity associated with that card remains on your credit report for up to 10 years. For consumers wanting some idea of whether or not they might have too many cards, FICO occasionally publishes "high achiever" statistics that highlight common attributes of consumers with scores greater than 785. You may be interested to know that their latest findings show that the typical high achiever has seven credit card accounts (both open and closed) on average.
Summarizing all of the above information into some basic guidelines to follow, as you prepare for a home purchase:
- Leave those 10 cards open and keep them active.
- Continue paying your balances in full each month.
- Avoid applying for new credit.
And lastly, as you've now learned, don't believe everything you hear!
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