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When it comes time to buy a home, you’ll have to get your financial ducks in a row. You need to save for a down payment, make room in your monthly budget for mortgage payments, and confirm your credit score is up to snuff. That last factor will play a huge role in what your mortgage lender may offer you.
With all this emphasis on your credit score amidst the mortgage application process, you’re probably curious about what happens to your credit score once you do buy a home. You may even feel anxious about your credit score taking a hit.
So, does buying a house hurt your credit? Does it impact it at all? Let’s investigate.
How does buying a house affect your credit score?
The purchase of a home does not affect your credit whatsoever — if you pay in cash. Only purchases made on credit affect your credit score. Since most of us need a mortgage to help finance the purchase of a home, it’s important to look at this issue through the lens of how a mortgage affects your credit.
A mortgage can affect your credit score both positively and negatively.
When you take on a mortgage, you agree to make on-time payments each month for anywhere from 10 to 30 years. Your payment history is the number one factor that influences your credit score, so a mortgage gives you a lot of potential to strengthen your score. On the flip side, if you miss some of your mortgage payments or are late to make them, your credit score will take a hit.
Another way a mortgage positively influences your credit score is by diversifying your credit mix. When you have different types of credit, such as auto loans, a mortgage, and credit cards, this mix helps improve your credit score. Lenders like to see that you can manage all of those different forms of credit properly when you make on-time payments for them.
As you can see, if managed well, a mortgage really helps you improve your credit. That being said, you will see a bit of a dip in your score right after you take on the mortgage. When you apply for your mortgage, the lender will need to do a hard credit inquiry in order to review your credit report and approve you for the mortgage loan. Hard credit inquiries temporarily knock a few points off your credit score. The key word here is temporary, so don’t worry about it too much.
Can you buy a house if you have bad credit?
A bad credit score hurts your chances of getting approved for a mortgage and receiving a more favorable interest rate. Lenders typically approve borrowers with credit scores over 620, but scores of 700 or higher are more likely to qualify for better interest rates.
Even if you have a bad credit score, there are lending options out there that cater to borrowers with low scores. For example, VA loans don’t require a specific credit score and FHA loans only need a score of 580.
Request a copy of your credit report from all three major credit bureaus (TransUnion, Equifax, and Experian) to learn what your credit score is, so you can have a better idea of what type of mortgage you’ll qualify for. Each credit bureau will give you access to your report for free once a year.
While you review your credit reports, check to make sure everything listed on each report is accurate. If you find an error on one of your credit reports, alert the credit bureau that made the mistake so you can begin to work together to correct it. If there are errors on your report that hurt your credit score, you can boost your score quickly when you fix them.
If you need to improve your credit score quickly, you can also pay off any outstanding debt you have in collections and pay off your credit card balances. How much of your available credit you use also impacts your score. When you pay off your credit card, you quickly improve your credit utilization rate (also known as “amounts owed”), which accounts for 30% of your credit score.
Even if you have a low credit score, it may still be worth it to apply for mortgages as lenders also take the “The Five Cs” of credit into consideration, which can make you a more desirable loan candidate.
- Character: Your credit history
- Capacity: Your debt-to-income ratio
- Capital: The amount of cash you have
- Collateral: An asset that backs the loan
- Conditions: The reason for the loan, amount of the loan, and any relevant interest rates
Should the impact on your credit score dissuade you from buying?
One of the most important purchases any of us ever make on credit is when we buy a home. That’s why you want your credit score to be in the best shape possible before you purchase a house. After all, the interest rate your credit score earns you today will be with you for up to 30 years. You can save a lot of money over the life of a loan when you secure a lower interest rate.
The point being: When your credit score takes a small dip after you buy a home, it’s okay. You just used your credit score to make a really important purchase and you can easily bounce back from the slight hit your credit took.
How to boost your credit after you apply for a mortgage
If you still feel nervous about the drop your credit score will take after you apply for a mortgage, you can make a plan to improve your credit score. To do that, it’s important to understand the factors that affect your credit — that way, you know what healthy credit habits you need to form.
A few different factors affect your FICO credit score. While FICO is not the only credit scoring model on the market, it is the most commonly used model. These are the factors that FICO takes into consideration when they calculate a credit score.
Payment history: 35% of credit score
Your payment history reflects whether or not you made payments to your past and current credit accounts on time. This factor contributes to more than a third of your credit score, so it’s extremely important that you make your payments on time, every time. To avoid accidentally missing payments, set up autopay so you don’t have to worry about forgetting to pay a bill. Just make sure you always have enough funds in your account so you don’t overdraft when a bill automatically gets paid.
Amounts owed: 30% of credit score
Your “amounts owed” (this is the credit utilization rate we talked about earlier) reflects 30% of your credit score. As a rule of thumb, you want the amount of debt you use compared to the amount you have available to you to be less than 30%. So if you have $20,000 worth of credit accessible to you, you should aim to use no more than $6,000 of it.
Length of credit history: 15% of credit score
Another easy way to keep your credit score healthy is to not close any older credit accounts if you can help it. The longer history of credit you have, the better. Whenever possible, keep older credit accounts open. The exception to this rule would be if you need to pay an annual fee. For example, if a credit card you no longer utilize has a $500 annual fee, you should close the account. If the credit card in question has no fee, then it is often worth it to keep the account open for the time being.
Credit mix: 10% of credit score
Your credit mix represents the variety of debts you have. If you have a student loan, an auto loan, and a credit card, all of those different types of credit contribute to a varied credit mix — which is a good thing.
New credit: 10% of credit score
The new credit section of your credit report shares the new accounts you opened in the past year. If there are too many new accounts on your report, lenders will worry you’re a risky borrower. You should avoid opening too many new credit accounts throughout the year leading up to your mortgage application.
Whether you’re years away from buying a home or just purchased one, it’s always a good idea to take care of your credit score. You’ll find a lot more financial doors open when you have a stellar score.