If you’ve ever had difficulty with consumer debt, or have overused credit, you’ve probably been advised to cut up your credit cards. Canceling your cards may help you spend less but you might want to consider how they can affect your borrowing ability.
I’m a huge fan of Dave Ramsey, the Christian money-management guru. He’s smart, opinionated and he speaks from his experiences, both good and bad. He teaches people in tough financial situations to “stop being stupid” with credit, get out of debt, and live within their means. Unfortunately, he also tells people to cut up their credit cards.
Now, I definitely don’t think that anyone should carry enough credit to be able to purchase a Lamborghini on a card, but it is important to have a certain amount of credit and use it wisely, especially if you want to get a mortgage. In Ontario, Canada, lenders typically want to see two trade lines active for at least two years. That means if you cut up your credit cards, you may have trouble getting the funds to purchase a home.
Your Credit Score and Your Mortgage
In Canada, if you’ve ever used a credit card, applied for a loan, or opened a cell phone account, you will have a credit report on file with the consumer credit reporting agencies, Equifax and Transunion. You can request a report yourself, from either agency. They’ll charge you to send it digitally or they will send it by snail mail at no charge. You might also be able to sign up with your bank to get the information for free. It’s a good idea to check your credit report once or twice a year to keep on top of possible errors or fraudulent activity.
These credit reporting agencies use a variety of criteria to assign each person a credit score. You may have heard it called your FICO score or your Beacon score. Some of the elements they use to determine your score are the number of trade lines you have, the type of credit you use (personal loan, credit card, line of credit, etc.), and the amount of debt (or credit utilization) you have.
Lenders Want to See Responsible Credit Use
You might think, as Dave Ramsey does, that using cash for everything is the best way to go. While this is a very wise way to live, mortgage lenders don’t see it that way. When you apply for a mortgage, lenders check your credit bureau to determine whether you are a good risk or not. In most cases, they will look at a file with little or no credit history in the same way as a file with bad credit. They may even jump to the conclusion that you’ve had a bankruptcy, if you are older and have no credit. They want to see that you use credit and you are willing to pay it off. Bonus points for files with different types of credit such as cards, monthly installment loans and lines of credit.
Tips for Using Credit Responsibly
You don’t have to use a lot of credit to keep your credit report in good shape. If you’ve never had credit before, or you are starting to rebuild your credit keep these tips in mind:
It’s okay to keep your limit small – When credit card companies send out credit limit increases, if you don’t want to be tempted, simply ignore them.
Use it occasionally – Use credit for occasional purchases, once every 1-3 month, or set up a monthly bill payment such as a utility bill. Using it once in a while will ensure the card company updates the credit bureaus.
Pay off the balance – Paying a card off as you use it, means the bureaus might not get the information. Wait until your statement comes in and pay off the balance before the due date.
Don’t be tempted by rewards – Free stuff sounds great, but it doesn’t make sense to pay more in interest than you are receiving in rewards.
Keep your oldest card – The age of your credit history counts. If you are thinking of cutting up the cards you no longer need, keep your oldest card, especially if it shows that you pay as required.
Consider your utilization – If you are using credit, your report will look more favorable if you are using less than 30% of your limit. When you consider closing accounts, keep this limit in mind.
I seriously love the idea of living on cash, but when it comes to getting a mortgage, I recommend that you keep some credit and use it responsibly. When it’s time to borrow money to purchase a home, you’ll show the lenders you’ve got the right stuff.
Shari Talbot is a licensed Mortgage Agent, with Select Mortgage Corporation. License # M19000423 Brokerage # 12908