One of the top reasons to maintain a good credit score is because it can help you secure a low interest rate on a home mortgage. In fact, a poor credit score can even disqualify you from a mortgage. But if you somehow manage to do get a home loan with a poor credit score, you’ll likely pay thousands of dollars extra in interest payments than if you had a better score.
Home ownership is still central to the American dream and a big goal for most people. It is also usually the largest loan an individual will have in their entire lifetime. Being approved for a mortgage and also securing a low interest rate all depends on your credit score and history at the time of application. If you are approved for a mortgage, it is generally agreed upon that you are considered a trustworthy borrower, otherwise why would the lending institution take a chance on you at all?
But once you have been approved for a mortgage and moved into your new home, what happens to your credit after you’ve signed on the dotted line?
Expect an Initial Drop
The process for taking out a mortgage is similar to taking out a car loan or other form of financing and impacts your credit in similar ways. First, the lenders will take out a hard inquiry on your credit to get a thorough look at your history. This hard inquiry will ding your credit a few points, but not significantly. It’s important to note that if you shop around for mortgages, multiple inquiries will only appear as a single inquiry if they are done in a 45-60 day period. It is always a good idea to shop around for the best rates, so take advantage of your 45-60 day window.
Once you have been approved for the mortgage and the amount shows up on your credit report, you can expect a relatively significant drop in your score. But this makes sense, as approximately 35 percent of your credit score is based on your ability to repay debt. Once you make consistent on-time payments, you will start to see your score improve again. During this period of initial repayment, it is wise to put off applying for additional loans or adding new lines of credit. This cooling-off period will give your credit time to bounce back from the hit from the mortgage, and ensure you get the best interest rates from having a solid credit score and history.
Benefits of Installment Debt
A mortgage can be a great tool to diversify your credit and can be a good sign to other lenders of your financial responsibility. The various kinds of debt you have account for approximately 10 percent of your credit score. A mortgage is considered “good” debt, or installment debt, because it has a physical asset attached to it, unlike a credit card. If you are unable to make payments on your house, the bank or lender can repossess the house and regain some of their capital. A credit card company, on the other hand, loses out if the borrower fails to pay. A credit card is in the category of revolving debt because the amount of debt fluctuates and is not attached to a tangible asset.
In general, it is a good idea to have both revolving and installment debt on your credit report. A mortgage is a great way to include some installment debt in your credit mix, and will work in your favor over the long run. As long as you make your mortgage payments on time, that is.
Making your Payments
As with most things in life, great responsibility comes with great risk. This is also true of a mortgage. Missing a payment on your mortgage is more significant than missing a payment on your credit card and can result in a bigger hit to your credit. This is because a mortgage is larger and more secured, so missing a payment is considered a higher risk than missing a payment on a smaller loan. Additionally, losing your home to foreclosure will also be a bigger hit on your credit than defaulting on a credit card, and can stay on your credit history for many years.
On the other hand, mortgages usually come with significant repayment terms, typically 15 to 30 years, and this provides a great opportunity to build your credit repayment history and increase your score over time. As mentioned above, payment history makes up 35 percent of your credit score, which is the most significant contributing factor. Over time, your ability to make on-time mortgage payments will lead to a better credit score and a better chance of securing other loans with low interest rates.