Buying a house and getting a mortgage is still considered a big part of the American Dream. But as recent years have proven, it’s still risky to take on such a large amount of debt.
Like with all debt, a mortgage requires leveraging your future income. But it could be worth it to you and your family, as long as you understand the pros and cons.
Let’s try to answer the question “How does a mortgage affect your credit score?” and see how this could affect your financial stability in the future.
Too Many Credit Inquiries Could Backfire
In a perfect world we’d all be able to pay cash for our homes and not have to be in debt to a mortgage company. But even when you save up past the standard 20% down payment, you’ll likely need a bank to help cover the rest of the loan.
Before you can buy a home, the first step is to prepare and get pre-approved for a mortgage, so you know if you’ll be able to afford the house you really want, and if a bank is willing to give you some lending power. Also, most real estate agents will only work with you if you’ve been pre-approved, since it’s a sign you’re a serious buyer.
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In order to get pre-approved for a new mortgage, you’ll have to turn in financial documents like your tax returns, pay stubs, W-2s and let the potential lender run a credit check. Doing a credit inquiry can put a “ding” on your report, although if you have several lenders doing a credit check around the same time (within 30 days of each other) the credit bureaus will usually count these as just one check, which is good. However, even one hard credit inquiry can lower your credit score.
Mortgage Debt is Considered Responsible Debt
Even with an unstable housing market in the past few years, having a mortgage is still considered “good debt” because it’s debt that’s tied to a physical asset — unlike credit card debt that’s not backed up by any asset.
Lenders want to look at your credit report and see you have a variety of debts – mortgage being one of the best types on the list. If you have a good payment history, the more you use credit, the higher your rating will be.
The reason many lenders consider mortgages as responsible debt, is because it shows you’re dedicated enough to take on a mortgage and make the payments. So as time goes on, your credit rating will increase because of this fact (as long as your paying on time).
A Mortgage Rounds Out Your Credit History
Around 10% of your credit score is determined by the type of credit you have in your report. The goal is to mix up your credit history with personal loans, credit card, and car loans, versus only having one type of credit.
Over the long-term, having mortgage debt improves your credit mix and can help increase your credit score. Having multiple types of credit indicates you’re able to handle different types of credit products, and shows you’re less of a risk.
You Have Less Available Credit
Your credit history is primarily used to determine your capacity to repay your debts. If you have a large amount of debt, versus the amount of credit available, you could viewed as a high risk.
Since your debt-to-income ratio is much higher, banks will see you as having less money to pay off your other debts, like credit cards or student loans. Be sure not to take out other types of loans during the time you’re buying a house (no matter how much you want new furniture!), since it could derail your mortgage loan success.
How a Mortgage Affects Your Credit Score
The immediate effect of taking out a mortgage will likely make your credit score go down slightly, but over the next six months to a year, the positive effects of making your payments on time, plus adding another layer to your credit mix, will likely improve your overall credit history and therefore your credit score will also improve.
Just remember, having a mortgage can help your credit but only if you get a mortgage you can handle and manage it well (and make timely monthly payments). In the end, it is possible to have a mortgage along with a strong credit rating!
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