One of the most common questions I hear is, “Should I pay off all my debt before applying for a mortgage?”
The answer surprises many buyers: Not always.
Paying off debt can improve your financial picture, but paying off—or worse, closing—credit accounts at the wrong time can actually lower your mortgage credit score.
Why You Shouldn’t Automatically Close Credit Cards
Your credit score isn’t based solely on how much you owe. It also considers the age of your accounts, available credit, payment history, and credit utilization.
When you close a credit card, you eliminate part of your available credit, which may increase your utilization percentage and lower your FICO® score.
For borrowers preparing to qualify for a mortgage, it’s usually better to discuss any account closures with your loan officer before making changes. This is where a mortgage consultation comes in handy early in the process.
Additionally, just paying off all debt early in the process could use up funds that could have been a resource for acquiring a superior loan product. I highly suggest mortgage planning 2-3 months before you actually apply, if there are questions.
Understanding Credit Utilization
One of the largest factors affecting revolving credit scores is debt utilization—the percentage of your available credit that’s currently being used.
Here’s an example:
- Credit card limit: $10,000
- Balance: $8,000
- Utilization: 80%
An 80% utilization ratio is generally viewed negatively by the scoring models.
Now consider these balances:
- $3,000 balance = 30% utilization
- $1,000 balance = 10% utilization
- $300 balance = 3% utilization
Generally speaking, the strongest mortgage credit scores are often achieved when revolving utilization remains below 10%, with many credit experts targeting 1% to 9% on revolving accounts. Using credit responsibly while keeping balances low typically produces better results than carrying high balances or maxing out available credit. Additionally, this can dramatically impact your Vantage Score.
If I Pay Off a Credit Card, Should I Close It?
In most situations, no.
If the account has no annual fee and is in good standing, leaving it open may help preserve your available credit and strengthen your utilization ratio.
Every credit profile is different, so always discuss your strategy with your mortgage professional before making changes.
Should I Pay Off Debt While I’m in Escrow?
Generally, avoid making major financial changes while your loan is in process unless your lender specifically instructs you to do so.
Paying off debt can change your credit profile, alter your debt-to-income ratio, and sometimes trigger additional underwriting review.
If underwriting requires a debt to be paid off, your lender will explain how and when to do it. Otherwise, many borrowers are better served by maintaining the same financial picture through the close of escrow.
Paying off debt outside of escrow can be an extremely unnecessary burden or stress on the consumer because you typically need to show proof of funds to pay the account, proof it was paid and cleared, and then typically a conference call with the credit vendor to double-confirm the account has been paid in full — through what is known as a credit supplement. This is 3-4 additional things the borrower would need to do, for each account, versus just paying off through escrow at closing.
What About Collections and Charge-Offs?
Many consumers believe paying off a derogatory account, old collection, or charge-off will automatically increase their credit score.
Unfortunately, that’s not always how mortgage credit scoring works.
Depending on the credit scoring model and the age of the account:
- Your score may increase, rarely.
- Your score may remain unchanged.
- In most cases, the account’s updated activity can temporarily dramatically drop the scoring.
The impact varies by borrower and by the mortgage scoring models used. For that reason, it’s usually best not to pay derogatory accounts, collections, or charge-offs solely to improve your mortgage score without first reviewing the strategy with your loan officer.
Final Thoughts
When preparing for a mortgage, every credit decision matters. Closing accounts, paying off debt, or settling collections without a plan can sometimes produce results that are the opposite of what you expected.
Before making changes to your credit profile, speak with your mortgage professional. A well-planned upfront mortgage strategy can help maximize your mortgage score, improve your financing options, and put you in the strongest possible position to buy a home in the Temecula Valley.
