Whether it’s your first time buying a house or your fifth time, the home-buying process can be a lot to understand, especially how it will impact your finances beyond just a monthly mortgage payment.
One of the most important factors to consider when purchasing a house or even applying for a mortgage is the effect that it will have on your credit score. Mortgages, like other large purchases used with credit, negatively and positively impact your score, provided you make your payments on time.
Before considering buying a house, make sure you are familiar with the different ways a mortgage can affect your credit score.
Mortgages and Credit Scores
As you start searching for your perfect home, ensure that your credit score is in a good spot and that you haven’t opened any new credit accounts. Having a good credit score is the key to finding the best rates from lenders, as they want to make sure you are in good financial standing and are able to pay back the loan.
Credit scores can range from a low of 300 to a high of 850. The higher your credit score, the more likely you are to prequalify for a loan. Most mortgage loans require a score between 580 – 620. However, if your score is higher than 620, there is a chance you may be able to save more money with lower interest rates.
If you do have a lower credit score and have the option to wait before purchasing a house, it may be better to do so and work instead on building up your credit. A higher score may allow you to save money in the long run.
How a Mortgage Loan Can Hurt Your Credit Score
For the most part, mortgages can help raise your credit score. However, there is a period of time when you first buy your house that your score may drop a little due to a few reasons.
The first step to buying a house is applying for a mortgage and becoming prequalified. All lenders will do a soft credit pull for pre-qualifying; some may go a step further and run a hard pull.
A soft credit pull will not affect your credit but will still allow the lender a good view of your credit score. On the other hand, hard pulls count towards your credit score and can lower it. This is often not a large drop; most mortgage inquiries will lower your score by about 5 points. If you have a high credit score, it may be less than 5 points.
When you are searching for the right lender, remember that it’s often a good idea to submit your application around the same time period. If you apply for a mortgage loan one month, then wait and apply for another two months later, the drop in your credit score will be further stretched.
Finalizing the Mortgage Loan
After finding the right lender and being pre-approved, your mortgage loan will need to be finalized. Finalizing your mortgage loan means a hard inquiry on your credit report to confirm your qualifications were correct. As with any mortgage inquiries, your credit should only drop five or so points, depending on your current score during this stage.
Once your mortgage is signed, and you are officially a new homeowner, your credit score will take another hit over the coming months. This is because credit bureaus and scoring models won’t have any proof of successful payments, as you haven’t started paying on the mortgage yet, causing a drop in your credit score.
Your score may also drop because it is a new account and will decrease the average age of all your accounts on credit. On average, those with good credit have their scores drop by 15-20 points when signing a new mortgage loan.
Unpaid Mortgage Loan
Life can get chaotic, and sometimes you may not be able to make your mortgage payments. If something happens and you aren’t able to pay, even just once, it will be reported to the credit agencies and can negatively impact your score.
The missing payment will stay on your credit report for the next seven years, but its effect does not significantly impact your score over time. One late payment, though, is better than several late payments, which will cause your loan to go into foreclosure. Foreclosure means that your house may be seized and will greatly impact your credit score.
Before missing payments, if you think you can’t pay your mortgage loan, talk to your lender to see if they are able to help you adjust the payment schedule or work with you to avoid any problems.
How a Mortgage Loan Can Improve Your Credit Score
Although it sounds like mortgages do more harm than good when it comes to credit scores, mortgages can actually help you to improve your score once the initial drop occurs. Owning a home is highly beneficial to building up your credit portfolio and creating a strong credit score, though it may take time.
With a mortgage loan, three important factors go into raising your credit score:
Payments – The most important part of a mortgage loan and your credit score is to make sure you pay on time. Even missing just one payment can have a negative impact, but paying on time and steadily over the term of your loan will help raise your score.
Credit-Mix – If you haven’t owned a home before, adding a mortgage loan to your mix of credit accounts shows that you can handle multiple types of credit beyond traditional credit cards. The more variety and on-time payments in your credit history, the higher your score can climb.
Credit History – Building credit takes time. With a mortgage loan, most terms are for 30 years, allowing for a long-term account showing that you can repay your loan on time.
How to Raise Your Credit Score and Keep it Healthy
Whether you are looking to buy a house or have bought a house and want to keep your credit score healthy, there are a few things you can do, such as:
- Pay all your open accounts on time, including your mortgage, car payments, and credit cards. If you can, pay off all your credit cards each month to keep a low balance and ensure that revolving credit is low.
- Check your credit score often, especially before applying for any new credit. Many credit cards and banks offer free services, so you don’t have to make a hard inquiry to see your credit score. Being informed will help you stay ahead of any problems.
- Don’t apply for new accounts too frequently. Although that store credit card may be tempting, any new inquiries into your credit will cost it a few points. Over time that can add up and hurt your credit score. Instead, carefully consider which credit accounts you want to open. Remember, having a mix of different types of accounts can help improve your credit score.
- Make sure you are up to date with any past-due bills. As with a late mortgage, missing payments stay on your credit history. However, paying them off as soon as possible can help and ensure no other late payments are added. If you are having trouble paying off your bills, consider talking to a credit counselor who can guide you.
How does a Mortgage Affect Your Credit Score – The Bottom Line
Becoming a homeowner is an exciting opportunity that can be beneficial for years to come. While there may be an initial drop in your credit score while qualifying for a mortgage, raising it and even increasing it over time is possible. Mortgage loans are great additions to your credit history, as long as you make payments on time, not to mention they allow you a home to build your life in. If you are ready to start your journey to becoming a homeowner, talk to one of our experienced lenders.
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Information contained in this blog is for educational and informational purposes only. Nothing contained in this blog should be construed as legal or tax advice. An attorney or tax advisor should be consulted for advice on specific issues.