My credit card company told me today that the credit bureau actually treat our credit card limit as debt when they calculate our debt-to-income ratio. It doesn’t matter whether we spend $30 or $3000 if our credit limit is $5000 because they just put $5000 as debt when they look at your credit because it is believed that since credit card is discretionary spending, it can be used in an instant so the worst case scenario is used.
This was very surprising to me but very beneficial because the lady over the phone also explained that if I were to apply for a mortgage, I should decrease all the credit card limits to make sure that I get the loan qualified. (Yes I was surprised that a credit card customer service agent was actually helpful, not to mention that I could perfectly understand this lady’s English).
Let me provide a theoretical example: Conventional loan financing are typically 28/36. This means for an individual to qualify for this type of loan, a maximum of 28% of monthly income can go to housing expense, and 36% of monthly income can go to housing expense and debt repayment.
Someone who makes $48,000 and have credit limits of $10,000 each on 2 different credit cards and no other debt:
$48,000 / 12 = $4,000 monthly income
$4,000 x 0.28 = $1,120 can go to housing expenses
$4,000 x 0.36 = $1,440 can go to housing expenses + paying off debt
With $20,000 credit card, the theoretical minimum payment is $20,000 * 0.025 (2.5% is typical and rough calculation for minimum payment) = $500. So instead of letting you borrow as much as $1,120 per month for your mortgage, you can only borrow $940 to still be qualified as a conventional loan.
What’s the difference of $180? With a 30-year fixed mortgage at 7%, $180 works out to be around $27,000. Quite a bit of borrowing power.
If we increase the debt repayment portion to be 2 x minimum payment (as suggested by some), the difference would be $680 and the borrowing power might be reduced as much as $102,000.
What Do You Think?
After doing the calculation, $100,000 seems like a huge difference when considering all the difference was asking the credit card company to lower the credit card limit. What do you think? Have you heard of anything like that? Would you believe the lady on the phone?