As I’m sure you already know, when financial institutions approve you for a credit card or a loan, you are assigned a credit limit.
Let’s say you have:
- VISA – $5000 limit
- The Children’s Place card – $1,000 limit
- Unsecured Line of Credit – $10,000 limit
If you max them all out with an intention to pay minimum payments only, next time you apply for credit an unpleasant surprise might be waiting for you!!
LENDERS WILL SEE IT AS AN OVER-RELIANCE ON CREDIT, AND TRY TO MANAGE THEIR RISK AGAINST YOU POSSIBLY OVER-EXTENDING AND DEFAULTING ON PAYMENTS.
WHAT DO LENDERS WANT TO SEE?
Lenders like to see that you use your credit products and pay them off, or even if you carry balances, they are manageable at your income level.
Makes sense, I think???
- Credit scoring models give you most points for utilization up to approximately 30% of your credit limit.
- That shows them that you manage your credit file well, and are responsible.
- They start getting a little nervous if your balances top 50% of your credit limit.
- Go over 75%, and risk averse bankers will have a panic attack , and your credit scores start dropping like a rock!
Recently, one real estate investor raised some good questions on www.myreinspace.com.
He wanted to understand how utilizing your credit lines impact credit scores. Are all credit products created equal, i.e. if you maximize your secured line of credit, unsecured line of credit, or a credit card – will the resulting impact on your credit score be the same or different?
Let’s walk through an example.
Four people have a credit limit of $10,000 each. Each of them has a $10,000 balance.
- Person A carries this balance on a secured line of credit
- Person B on an unsecured line of credit
- Person C on a VISA, and
- Person D on a department store card
Let’s assume all four have exactly the same income and identical credit files in good standing.
Who do you think would worry you more?
- Person A pays interest only on his secured line of credit at prime rate. That is $25 per month.
- Person B pays interest only on his unsecured line of credit (yes, there are unsecured lines like this) at prime + 4%. That’s $58 per month.
- Person C pays 3% of balance plus annual interest rate of 18%. That’s $450 per month.
- Person D pays 3% of balance plus annual interest rate of 28%. That’s $533 per month.
This very simplistic example demonstrates: credit products are not created equal!!!! They pose different levels of risk to lenders, and different levels of stress on your ability to pay.
SO WHAT’S BEST?
Clearly, the Home Equity Line of Credit’s (HELOC) secured line of credit is the safest.
It is secured against equity in your house, and your payment is the lowest of the pack.
If you were to use it for investment purposes (utilizing it to the max.), it would not hit your credit score anywhere near what, say a department store card would.
Avoid carrying balances and paying minimum payments on your credit cards.
Pay them off IN FULL, EVERY MONTH, when the balance is due!!!
OH AND BY THE WAY… ALWAYS BACK TO OUR TENANTS…
WHEN YOU QUALIFY A TENANT, THIS IS SOMETHING TO KEEP IN MIND!!
If your prospect tenant has several credit cards on their credit bureau file with high utilization, you can easily add up the payments they have to carry every month and see what portion of their income goes towards servicing debt.
At the end, do they still have enough to pay rent?
Best of Luck!