When you apply for a mortgage, you usually don't need to pay off all of your credit cards. However, it's normally better to have less debt than more debt. This can be especially true if you're applying for a jumbo mortgage on a high-value home. Because these loans aren't subsidized or insured by the government, investors typically are more concerned about the quality of the credit underlying them.
One of the largest components of your credit score is how much of your available credit you utilize. The closer you are to your credit limit, the lower your score will be, and the harder it will be to qualify for a mortgage. Although the algorithm used to calculate your score varies depending on which agency is doing the score, keeping your utilization well under 30 percent on each card should help a great deal. This means that if a card has a $20,000 limit, you should owe less than $6,000 on it.
Another factor in qualifying for a loan is your debt-to-income ratio. Lenders calculate your loan-to-income ratio by comparing your monthly projected mortgage payment to your monthly gross income. But they also look at all of your debts to calculate your debt-to-income ratio. If you have too many credit card payments, that could end up reducing the size of the loan for which you qualify. Although a 45 percent debt-to-income ratio is a good rule of thumb for a jumbo mortgage, the figure can vary depending on your loan, lender and situation.
Freeing Up Monthly Income
One of the benefits of paying down your credit cards is that it reduces your total monthly payment load. Given that mortgage payments and the other costs of homeownership are frequently more than the cost of renting, you might experience payment shock. Having lower credit card payments helps to mitigate that shock. If you already have a mortgage and are just looking to refinance, you might not get payment shock with your new loan, but it's still always nice to have more money left over after paying your bills.
Dealing with Collections
If you have credit cards with late payments, or if you have accounts that are in collections, the rules are a little bit different. On one hand, a lender will almost always require you to clear up any collections before granting you a new mortgage. On the other hand, generating activity on collection accounts can sometimes actually lower your score rather than improve it, since that could redate the account and make it a bigger part of your score. So it's best to work closely with a mortgage expert if you have negative items on your credit report.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.