The season of giving brings cheer for many, but before the holidays arrive, we need to discuss how holiday shopping can severely damage a credit score. More importantly, buyers with limited credit could receive a credit denial for a home purchase. Talk about “Bah Humbug!” To prepare you for the holiday shopping season, we’ve compiled a few best practices to help you stay on track and achieve your goal of homeownership.
We are constantly reminded of credit card specials, whether shopping in a store or online, “Open an account and receive a 25% discount off today’s purchases.” You might be thinking, “Hmmm, 25% off a $200 purchase is a $50 savings! Plus, everything purchased was on sale that saves an additional $50. So, that’s a $100 savings!” Sign me up. Not so fast! Let’s discuss the dark side of holiday spending.
How It Starts
Let’s say you open two department store credit cards to take advantage of a promotional discount’s potential savings. Each new card has a credit limit of $300, and you charge $270 to them. You’ve completed your holiday shopping and took advantage of the holiday deals. While this seems like a win, it’s not the best scenario for someone planning to buy a home soon. Here’s why.
Opening New Credit Hurts Credit Scores
On the surface, $270 in new credit card balances looks pretty good, but we just described a scenario that could hurt credit scores by 50, 100, or more points (and that’s without any late payments). There are three key areas negatively affected, which make up 55% of a credit score.
- Credit inquiries
- Age of credit
- Credit utilization
There must be a credit inquiry to receive the credit card. When the credit inquiry takes place, the store will pull your credit to determine approval. Credit inquiries make up 10% of an individual’s credit score.
Age of Credit
Next, there is the overall age of the credit, which comprises 15% of the score. Opening two new cards will lower the average age of a credit file. This is especially true for someone who has a thin credit file.
Finally, there is the big one – credit utilization, and it accounts for 30% of a credit score. Credit utilization means balance compared to credit limits as a percentage. The higher the percentage, the worse the damage to a credit score. Therefore, our example of owing $270 on a $300 credit limit is a 90% utilization. That’s bad, and if it happens before you submit your application or during the mortgage process, it can be catastrophic to your mortgage approval. But fear not, because improving your credit score could be as simple as making a few changes.
7 Tips To Help You Shop Smart and Avoid Credit Card Debt
Now that you know how credit cards can impact your home buying plans let’s go over a few strategies to ensure financial success in your gift-giving this year!
1. Set up a savings account dedicated to holiday shopping.
Keep a separate bank account and make small deposits throughout the year to dedicate to holiday spending. Only spend what you can save year-round. That way, you don’t have to rack up any credit card debt, and you can still shop online with a form of electronic payment.
2. Go old school and pay with cash!
Once the cash is gone, you’ll have to stop spending. If you shop with a credit or debit card, you’re less aware of how much you are spending. Having physical cash in hand will increase your awareness.
3. Hit the unsubscribe button or STOP
If you subscribe to an email list or opt into promotional text messaging to get a discount, make sure you unsubscribe after getting the promotional offer. Unsubscribing will help you avoid the temptation to spend more or buy something you don’t need due to a promotional offer.
4. Avoid opening any new lines of credit without consulting your loan officer first.
It’s risky to open a new line of credit while you’re in the market for a home. Doing so can put a kink in your plans if the new account negatively impacts your credit score. Be sure to call your loan officer before opening any new lines of credit. They will help you determine the right course of action.
5. Don’t add a balance to your credit card unless you plan to pay it off in full before the bill is due.
Tip #5 is a general personal finance best practice. It’s also an essential rule to follow during the mortgage process to avoid collection interest and negatively impacting your debt-to-income ratio or credit score.
6. Search for holiday deals using tools like Honey.
Back to the promo codes – Honey is a fantastic tool that will help you identify promo/discount code opportunities when you need them.
7. Make a shopping list.
If you determine who you need to shop for in advance, there will be less temptation to buy gifts for everyone that comes to mind. Stick to your list and only buy gifts for the folks on your shopping list. Pro tip: Take this a step further by setting a spending limit for each person on your list.We wish you happy holidays, smart holiday shopping, as well as happy house hunting! Contact us now to start the holiday home-buying season off right.