Sometimes the pursuit of perfect credit leads us to worry about utilizing the very products good credit gives us access to. A healthier way to look at credit would be to know that there are times to build credit, and there are times to use credit — and that these two stages often occur simultaneously.
One example of this is buying a home. With the average value of a home in the U.S. hovering at $213,000 (as reported by Zillow for September 2019), it’s unlikely that the average American can buy a home without the assistance of a mortgage. That’s where worries about credit might come in: Is my credit good enough to get a mortgage? And how might a mortgage affect my credit?
Is this worry necessary, especially when piling on top of the already stressful prospect of buying a home? Read on to find out.
How a Mortgage Affects Your Credit
No matter the value of the home you buy, a mortgage is likely to add a large amount of debt to your credit profile unless you’ve paid a hefty down payment. This will likely, at first, cause your credit scores to take a hit, as will likely the act of applying for a mortgage (more on the latter in the next section).
However, as you pay your mortgage each month (assuming you pay the full amount due and always on time), your credit should start to trend upwards. That’s because you’ll be showing a positive history of on-time payments, and on one of the most difficult credit products to get. It might not sound like a huge deal, but the effect of those on-time payments is nothing to scoff at. Payment history is the most influential factor for FICO® credit scores.
Therefore, even though your credit scores can take a dip in the months after a new mortgage, you should see a rebound and an upward trend if you always pay on time. What’s more, unless you have an urgent need to buy a new car or obtain a new line of credit shortly after getting the mortgage, a short-term negative impact on your credit isn’t likely to impact your life.
There’s also another way a mortgage can improve your credit. Another factor in credit score calculations is something called “credit mix,” and it refers to the types of credit you have. Someone with a credit mix, say a mortgage and a credit card, has an opportunity to show how they handle different types of credit. If all other credit behaviors (such as credit utilization and payment history) are in good shape, then having a credit mix can help.
How Your Credit Affects a Mortgage
The more important question to ask about credit and mortgages isn’t what happens after a mortgage, but how your credit can impact a mortgage beforehand. That’s because your credit scores will likely greatly impact the price you pay on that mortgage overall.
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There’s a strong relationship between credit scores and interest rates, and the higher your credit scores, the lower the interest rates you’re typically given. This matters a great deal, as the interest you pay on a loan adds an overall cost to the loan that’s not as easy to see as a purchase price. Even a small difference in interest could potentially save you thousands of dollars over the life of a mortgage.
If you know a mortgage is in your future, then the time to start working on your credit would be now. Credit improvement doesn’t happen overnight, but consistent improvements can start to take effect in a matter of months. That effort can set you up for obtaining the best mortgage rates you can get. Here are some steps to consider taking right away:
- Pay all of your bills on time, credit and otherwise
- Reduce revolving debt, such as credit cards, as much as possible
- Handle any collections accounts or delinquencies that might be dragging down your credit scores
- Review your credit reports and dispute any errors you find
After you take these steps, there’s one more thing you can do to prepare your credit for a mortgage: Follow the rules of rate shopping when you apply.
How to Apply for a Mortgage With Minimal Damage to Your Credit
One way you can inadvertently damage your credit scores occurs when you need them the most is when you’re applying for a mortgage.
Any time you purchase something, it’s wise to shop around for the best price. Mortgages are no exception to this rule. The problem is, if you apply for too many mortgages to see which one comes back with the best interest rate, you could be effectively lowering your credit scores due to the points lost with each application. There is a way around this, however.
If you keep all of your mortgage applications to within a few weeks of each other and always for the same amount — while avoiding applying for any other credit at the same time — you can signal to the credit reporting companies that you’re rate shopping. In other words, they’ll realize you’re not planning on taking out all those mortgages, but rather seeing which one will be the best for you.
Another thing that can help is if you’ve been given any preapprovals. These do a soft credit check, which doesn’t affect your credit scores. You can compare preapprovals or even try for prequalifications, and then, if you only apply formally for the best offer, you’ll only get one hard credit check on your record. That would mean only a handful of points have to come off your credit scores, but you were still able to shop around for the best mortgage offer.
Balancing Financial Goals With Credit Goals
It can seem enormously difficult to try to improve your credit while also reaching toward financial goals that might seem to hurt it temporarily. It’s important to keep a balance of the two goals, and always to remember that one of the most important reasons to care about your credit is the financial opportunities it can lead to.
Using credit is an effective way of building it — so if you’re following good behaviors such as making all your payments on time and keeping revolving balances as low as possible, then you can rest assured that you’re treating your credit well.
[Make sure your debt doesn’t negatively impact your credit. Find out how.]