If you’re in the market for a house, you may be wondering how a large purchase (and mortgage) could affect your credit score. Will buying a house increase your credit because of the financial responsibility involved, or will the new debt result in a decrease?
The answer is a bit complex, as each person’s credit history and loan scenario are unique. This blog will offer some insight on how a home purchase could affect your overall credit rating.
Credit Score Basics
The three major credit bureaus are Equifax, Experian, and TransUnion. Each assigns a credit score, also known as a FICO® score, to individual consumers. If a consumer has not yet used credit or uses very little, that person may not have a traditional credit score. Some of the things that affect the scoring algorithm are payment history, the amount of revolving credit available, length of credit history, and payment history (i.e. whether or not you tend to make your payments on time). Credit bureaus are notoriously secretive about their scoring algorithms, but they do appear to follow basic common sense. If you pay your bills on time, your credit score will benefit. If you use credit conservatively and avoid opening too many accounts, your credit score will benefit. As such, consumers often wonder how a mortgage might affect their score. Is it viewed as a positive or a negative by the scoring algorithms? The answer: It could go either way depending on the bigger picture.
How Can Buying a House Help My Credit?
Payment history is crucial here. Make your first three payments on time. Read that again: Make your first three payments on time. A solid payment history on your mortgage is a strong indicator of creditworthiness that will likely do good things for your credit score. After making your first three payments on time, keep paying on time to continue growing great credit.
If you had existing credit but not a mortgage, the new home loan will diversify your credit portfolio, which is beneficial to your credit rating. This is sometimes referred to as “credit mix,” and having different types of credit in your mix is a good thing.
If you were not a consumer of traditional credit prior to the purchase of your home, then having a documented monthly payment such as a mortgage loan will help you to establish a FICO® score. Even if you paid rent in the past, your landlord may not have reported your payment history to the credit bureaus.
How Can Buying a House Hurt My Credit?
According to the Experian blog, a hard inquiry resulting from a mortgage preapproval credit check might reduce your score by a few points but “this score reduction is usually short-lived.” The main issue with credit scores and mortgages is payment history. A mortgage will likely represent the largest percentage of your debt, so late and/or missed payments will probably have a significant effect on your score.
If you took on a large amount of mortgage debt, or if you maxed-out your debt-to-income ratio during or after the purchase of your home, your score could be adversely affected. In other words, if more than 50% of your income is dedicated to monthly debt payments, this means it could be more difficult to pay your bills on time. It also means that additional debt is not advised, resulting in a lower chance that you would be approved for loans, credit cards, or an additional mortgage in the near future. Remedy this negative trend in your creditworthiness by waiting to acquire new debt and paying all current bills before the due date.
This next point is indirect but often happens in conjunction with the home buying process. Avoid running up your credit cards right after buying a home. It’s natural for new homeowners to get excited about redecorating and enjoying their new home. However, be cautious about how your purchases affect your credit score. Many home stores offer their own credit cards and installment loan programs. These will eventually show up on your credit report and too much revolving or installment debt can negatively affect your score.
Where to Start
Obtaining a mortgage and paying it on time will do good things for your credit score, far outweighing the temporary ding that results from your mortgage company’s inquiry. Click here to get started with a Ruoff Mortgage preapproval, or click here to find an approved Ruoff Loan Officer in your area.