With mortgage regulations becoming increasingly strict, it's important for those looking to refinance or secure a new home loan to be in the best financial shape possible.
There are many obvious best practices for getting your finances in order before applying for a loan. This includes paying your bills on time, getting your documents (W-2's, income statements, etc.) in order, and not taking on any other major loans (such as a new car). However, one practice that can have a major effect on a consumer's credit score is relatively unknown by loan applicants.
It's known as the 30 percent rule and it can have a tremendous impact on your credit score. Simply put, the 30 percent rule states that you shouldn't use more than 30 percent of your available credit. For example, if you have $10,000 in available credit, you shouldn't carry a balance larger than $3,000. Having a credit-use to credit-limit higher than that can decrease your credit score.
Why does this ratio have such a big impact? When the three major credit repositories see a consumer using less than 30 of their credit limit, it indicates responsible use of credit. Those who can use credit responsibly are seen as less of a risk when it comes to home loans. Since a credit score is an indicator of the ability to pay a debt back, this ratio can increase or decrease your score by dozens of points.
Tony Denman, one of Omaha's most awarded mortgage lenders, has seen clients increase their credit scores by as much at 100 points by reducing credit card usage to fall below the 30 percent ratio. Denman's practice, known as the Denman Team, works with proprietary software to determine client's ideal credit ratio. He recommends making debt reduction a priority when preparing to apply for a home loan.
For those who don't know their credit limits, free services such as Credit Karma are a convenient way to determine who much credit is available and what current usages are.