When you’re getting ready to purchase a new home, you’ll want to get your finances in the best shape possible. Paying off credit card balances, or significantly reducing them, can help you get approved for a mortgage with a low interest rate.
If you’ve eliminated some of your balances, or if you have credit cards that you haven’t used in years, you might think that closing those accounts will help you qualify for a mortgage. In fact, canceling credit cards can make it harder to get a home loan.
Closing a Credit Card Can Lower Your Credit Score
Several factors determine your credit score. One of the most important is your credit utilization ratio, or the percentage of the credit that’s available to you that you’re currently using. Your credit utilization ratio is calculated by adding up all the balances on your credit cards, then dividing by the sum of the credit limits on all those cards and converting that number to a percentage.
If you close an account that you’re not using, that card’s credit limit will no longer be factored into your credit utilization ratio. The total amount that you owe will remain the same, but your total available credit will be smaller. That will result in a higher utilization ratio, which can lower your credit score.
The length of your credit history also impacts your credit score. A long credit history can contribute to a high score. If you’ve had a credit card for a long time and you close the account, that will reduce the length of your credit history and cause your credit score to take a hit.
Canceling Credit Cards Can Make It Harder to Get a Mortgage
Closing one or more credit card accounts might cause your credit score to fall by a significant margin and interfere with your plans to buy a house. You might be unable to qualify for a loan with a competitive interest rate, or you might have trouble getting approved for a mortgage at all.
You Can Keep Your Credit Cards, But Not Use Them
If you’ve paid off a credit card, it can be a good idea to keep the account active. The card’s available credit will help keep your utilization ratio down and your credit score up.
Having a credit card active doesn’t necessarily mean that you have to use it. You can simply put an unused card in a drawer or use it occasionally to make small purchases so the card issuer won’t close the account due to inactivity.Â
In the months before you want to buy a house, focus on keeping your debt level and credit utilization ratio down. That will show mortgage lenders that you know how to manage debt and handle credit responsibly and help you get a loan with an affordable interest rate.
