Credit Card Debt
I have a friend who wants to condense her charge card balances, also known as debt consolidation. In December of 2009, the bank declined her application for a home loan due to the fact that she had a lot of credit that was revolving. (This was the credit with which she planned on paying the loan off.) Now that she wants to apply for a loan again, she wants to know if she should shut down her credit card accounts and try to have the creditors change her credit over to a loan with installments. She also asked me if she would be more likely to get a loan if the bank saw that she already had a loan with installments versus revolving credit. The following is the advice I offered her, along with facts and my personal opinions.
The New Plan
No matter how high your FICO score, there are always things that lower it. Mixing types of credit is one way your score can be affected adversely. Not using enough of the credit that’s offered to you can also lower your score. 30% of your credit score is made up of the credit scoring system viewing the amount of credit you’re currently using versus the amount you could be using. This amount is known as your “credit utilization.”
Shutting down your charge card account isn’t a good idea due to the fact that it will compromise your charge card history. The amount of time you’ve had your credit card accounts open is a big part of your score, also, and you wouldn’t want to lose that. Additionally, changing one or every charge card balance is tough to do and can also be very time consuming.
Home loan officers look past the FICO score and separate the front and back ratios of the spending you do. The main part of the ratio is the part of home cost as a percent of the total income you earn. The other part of the ratio is the set costs as a portion of all the income you earn. Both of these factors play a huge, important part in determining the bank’s decision on whether or not to extend you a loan.
As you can see, it may be the ratio percentages or her FICO score that was the reason my friend was denied for getting a loan. Several articles on the internet provide clearer, more detailed information on this topic. This article is only meant to offer simple suggestions and various opinions on this problem.
When you apply for a line of credit or a loan, it appears on your FICO report, and remains there for a couple of years. However, these inquiries will only affect your score during the initial year they appear. Should it be that you continually find yourself being denied loans late in the year, odds will be better once those applications for credit hit their one year mark. After a year, apply for the loan again. In the meantime, continue to work on paying off your remaining credit amounts that are owed. Remember, shutting down your credit card accounts is not recommended during this time.
Other factors need to be considered when dealing with a situation like the one my friend faced. The value of her home, the remaining amount that she owes on her initial mortgage, and the amount of debt on her charge cards would have been beneficial in helping to solve this problem. I’m not saying that turning charge card debt into a different form of debt (like a mortgage, for example) is the right choice, but it does seem better to me than closing a credit card account that has quite a bit of credit history attached to it.
Although you’ll most likely save some cash on the APR amount, you’re taking a chance at losing your home if you can’t pay the mortgage amount. Along with that fact, taking several years while you cover your spending from the past could cause an overall increase in APR cost. Think about all the possible outcomes before you get in over your head.
Even though it seems like a hopeless idea from my standpoint, consolidating your debts can be beneficial. In order for it to work, however, you must be very vigilant about spending only what’s in your budget. Monitor your credit card use as much as possible, and continue building good credit. When used incorrectly, consolidating your debt could force you to ring up large amounts with your charge cards, putting you at risk of being in a hard place.
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