Whether you’re a first-time homebuyer or have been around the house-buying block a few times, there’s no denying that purchasing a home is a huge financial decision.
You’ll most likely have to make some sort of down payment and commit to that monthly mortgage payment for 30 years (unless, of course, you decide to sell before then). Even so, the obligation should not be taken lightly.
Just from preparing to buy a home, you know that your credit score is an incredibly important number. It determines your eligibility for a home loan, and also plays a major role in determining your interest rate.
The higher your score is, the lower your interest rate will be, which can really affect your monthly payment. Hopefully, yours is in top shape when it’s time to buy, but it’s also important to consider what happens to your credit score after you actually purchase your home.
You might be surprised to find out that buying a home has both positive and negative impacts on your credit. Read on to find out exactly what to expect of your credit score when you get a mortgage, plus how to minimize any potential damage that could occur.
Credit Inquiries Cause Slight Drop
It’s smart to shop around for interest rates from different lenders when you’re looking for a mortgage. Interest rates can vary greatly depending on the lending company and the type of loan they offer you; however, it’s important to employ the right strategy when comparing those offers.
That’s because each time you apply for credit, whether it’s a mortgage, auto loan, or credit card, the inquiry is listed on your credit report and your score is lowered anywhere between five and ten points.
Unfortunately, if you have an excessive number of credit inquiries, lenders might think you’re in desperate need of cash and might be reluctant to lend to you. The dip in your credit score reflects this potential risk.
So how can you mitigate this issue when shopping for a mortgage? First, limit the number of lenders you apply to. You can also ask for a pre-approval to find out what interest rates you’d be eligible for. The difference is that instead of having a hard pull performed on your credit report, the lender only does a soft pull which doesn’t have any effect at all.
You’ll still have to go through the formal application (and hard credit pull) once you decide on a loan, but the pre-approval process gives you the opportunity to compare offers without any type of commitment.
Another way to protect your credit score from too many inquiries is to limit your loan search to two weeks. When evaluating your credit report, lenders realize that consumers want to shop around for different rates to get the best loan. So if you have several of the same type of inquiry listed in a two-week span, they’ll actually only be counted as a single inquiry.
Mark your calendar with the first date of your loan application so you can track how long your search has lasted. Not only can you keep your credit score intact, you’ll also keep yourself on schedule for getting your mortgage in order.
Expect Debt Levels to Jump
Your credit score could also take a hit because of the amount of debt associated with a mortgage, particularly if this is your very first time owning a home. Luckily, there is a good side and a bad side to this.
Let’s start with the negative. Since a home costs so much, your level of debt is going to skyrocket, especially if you’re a first-time homebuyer or someone who just upgraded to a more expensive home.
Think about it: Say your previous levels of debt included a small credit card balance, a student loan, and a car payment and that came to about $65,000 in debt. If you buy a $200,000 house, you’re nearly quadrupling your level of debt.
Yes, you were approved for the loan and can afford the payments, but that is still a big number to be added to your credit report, and your credit history will reflect this change. It’s not going to plummet by any means, but you will notice a decrease.
Another way your new mortgage can influence your access to credit is through your debt to income ratio. This isn’t part of your credit score, but it is part of how future lenders analyze your application for credit. Basically, your DTI is how much monthly debt payments you owe versus how much money you earn each month.
Rent isn’t included in your DTI but mortgages are, so the next time you go to apply for a car loan or refinance your mortgage, you’ll have to consider how much overall debt you pay each month compared to your pre-tax earnings.
Credit Mix and Timely Payments
Now let’s get into the positive effects that buying a home can have on your credit score. The first impact is that your credit mix becomes more varied.
This category actually accounts for 10% of your credit score, so having an installment loan like a mortgage helps compared to if you just had revolving credit like credit cards. 10% may not seem like a lot, but it can help offset some of the damage caused by the negative side of purchasing a home.
The most important thing you can do to increase your credit score is to pay all of your bills on time, and having a mortgage is a great way to add a positive history to your credit report. That’s because while most creditors report negative payments to the credit bureaus, many don’t actually report positive payments. So you’re penalized for negative behavior, but sadly not rewarded for good behavior.
Mortgage payments, on the other hand, are regularly reported to each of the three credit bureaus: Equifax, Experian, and TransUnion. And since your payment history accounts for 35% of your total credit score, having those on-time payments reported each month can really make a difference, especially over time.
Keeping Your Credit Score Up
Even after you’ve purchased your home, it’s still important to keep your credit in top shape. You never know when you’ll need credit again, and you’ll want to ensure you have access to the best rates. You don’t even have to be preparing for a new loan like a car loan or personal loan.
You may want to refinance your mortgage in a few years to get a better interest rate, cash out some equity, or take off your mortgage insurance. In order to do any of those things, you’ll continue to need a strong credit history. Follow these tips to ensure your credit score stays where you want it to be.
#1: Monitor your credit report annually.
You can get free copies of your credit reports each year from AnnualCreditReport.com. This is helpful in a number of ways. First, it allows you to check to make sure all of your personal and financial information is listed accurately.
More importantly, however, is that it allows you to detect whether or not someone has fraudulently opened up any type of credit account in your name. Identity theft is a growing concern and staying on top of your credit report keeps your identity and your finances safe.
#2: Continue to make your payments on time.
It goes without saying that it’s vital to your credit health to make timely payments. Even one 30-day late payment can stay on your credit report for years, causing a major drop in your score. And the consequences just get worse as the delinquency ages to 60 and 90 days.
It’s easy to get swept away in all of the new excitement and responsibilities that come with a new house, but just be sure to keep up with your other financial obligations in the meantime.
#3: Keep your debt low.
Since you just added a large new mortgage to your credit report, it’s wise to keep your other debts as low as possible, particularly your credit card balances. Try not to exceed 30% of your available balance on any of your cards. If you do, your score is likely to fall. Instead, try to spread out your balances across cards while you work on paying them off.
While buying a house does indeed affect your credit score, it’s by no means such a dramatic impact that it’s not worth purchasing a house at all. After all, the purpose of the credit score itself is to help prove our creditworthiness to lenders so we can borrow money when the need arises.
As long as you can afford your monthly payments, purchasing a house could very well be a wise investment that allows you to put down roots while growing equity in your home.