Buying a home is such a large purchase that few people do so in cash. Most of you will use a home loan, or mortgage, to borrow the money needed to invest in property. While you need a good credit score to be approved for a mortgage, the mortgage itself will also affect your score going forward. All credit lines, mortgages included will be part of your credit history and factor into your credit score. But you may be surprised to know to what extent your mortgage plays in your credit picture. Potentially, applying for a mortgage can negatively and positively affect your score.
Your FICO credit score, which is the most widely used version, is made up of many factors. Based on FICO’s scoring method, here’s how taking out a home loan will impact your rating both positively and negatively:
Payment history (35%) This is the most weighted part of formulating your score. It takes into account whether or not you make your payments on time. Make sure you pay your mortgage on time and your score will be positively influenced.
Amounts owed (30%) When you first open a mortgage loan, you’ll owe a majority of the loan’s balance. Your credit utilization will be high. This will have some negative impact on your score. However, over time, as you pay your mortgage your rating will recover.
Length of credit history (15%) In time, your mortgage account will get older and this too will help your credit.
New Credit (10%) Initially, when you open your mortgage, you will see a small drop in your credit score. However, in about a years time, you’ll see a positive change.
Credit mix (10%) Adding a mortgage to your credit report can make an immediate improvement. Because your score is based on the variety of loan types, adding a mortgage can provide diversity to your credit.
Does a mortgage lower my credit score?
Unfortunately, yes but this is temporary and not something that should deter you from taking out a mortgage loan. A mortgage can make your score dip initially. However, please don’t let this discourage you.
Upon applying for a mortgage loan, the mortgage lender will do a hard inquiry which does adversely affect your score. Many times, mortgage lenders will check your credit at all three of the major credit bureaus and consider only the middle score to determine whether or not to grant you the mortgage and at what rate. You can see any hard inquiries on your credit reports. Don’t worry if you are shopping around for a mortgage. Multiple similar inquiries made within a short time are only considered as one hard inquiry which affects your score. Last, the drop in your score you should see rise again only in a few short months.
Additionally, the high balance of your loan also has a negative impact. As previously mentioned, as you make payments, your score should recover. This is a short term consequence for a greater gain.
Does a mortgage boost my credit score?
Yes, yes, and yes! Despite the initial drop, taking out a mortgage, as long as you make on-time payments, will do wonderful things for your credit score. The big reasons that a
- Payment History
- Length of Credit
- Credit Mix
A mortgage loan is usually extended over a time period of 15-30 years. Because payment history and the length of credit history are both factors in determining your credit score and creditworthiness, making consistent, on-time payments over time will largely affect your score. Payment history, makes up for 35% of your credit score. Your length of credit history makes up 15% of your score. Essentially, the longer you’ve been using credit and the more on-time payments, the better. This makes a mortgage loan the perfect credit type to establish history and payments.
Additionally, credit mix or credit diversity is another consideration into your credit score. Potential lenders like to see a variety of credit types in your history, like home and car loans as well as credit cards and more. A mortgage is considered an installment loan (differs from a revolving credit), where it is a set amount of money that has a fixed rate and scheduled payments. Generally speaking, the more variety in your credit, the better your score. A mortgage adds the perfect mix.
In the long run, a mortgage loan will build a strong credit foundation. It is well worth taking the leap and mortgaging a home. If you make regular payments you will have a long-standing loan with good payment history and it contributes to a good credit mix. This is all good for boosting your credit score.