Starting the home buying process for the first time comes with plenty of questions, and a steep learning curve. From pre-approvals to showings to mortgage rates, there’s no shortage of things you’ll need to learn if you want to increase your chances of landing your dream home, and at a price that you can afford.
One big question that first-time homeowners will likely find themselves with is whether or not their big life move will affect their credit score.
Keep reading to learn everything you need to know about how mortgages and buying a home will effect your credit score.
“Good” Debt Versus “Bad” Debt
If you’re like many people, buying a home will be the largest single debt you’ll ever take on. But while we could make a strong argument that no debt is good debt, certain debts are certainly easier to justify than others.
Some experts categorize mortgages, student loans, auto loans, and other similar, necessary debts as “good” debt. Other debts, like credit card debt or personal loans, fall under the category of “bad” debt. While this may be an overly simplistic way of looking at things, the fact that buying a home can be a smart move for your future does ring true.
Pursuing a college degree—and taking on the student loan debt that comes with it—might help you land a better-paying job or pursue your dreams. You may have no choice but to take on the debt of an auto loan in order to get to and from work, take your kids to school, or even get to the grocery store to put food on the table.
Buying a home is both an investment and a necessary expense. While renting may not require a mortgage, it also isn’t an investment. Buying a home means gaining equity and a property that may increase in value, and that you can sell in the future to get back the money you’ve invested.
Does Buying a Home Affect Your Credit Score?
The short answer is that yes, buying a home will affect your credit score. And unfortunately, that effect will be negative—at least at first.
If the only debt you’ve had in the past is credit card debt, it’s easy to assume that a mortgage will drastically drop your score, because your debt ratio will skyrocket. Luckily, this isn’t the case.
Installment Credit Versus Revolving Credit
Credit card debt is classified as revolving credit. With revolving credit, borrowers have a line of credit that they can borrow against. You can borrow any amount, up to your maximum, at any time. You’ll make payments each month, in addition to spending money on that credit card, which will cause your total to fluctuate. The amount you need to pay back each month will vary as well.
Mortgages, student loans, and similar types of debts are not classified as revolving credit. Instead, they fall under the category of installment credit.
With installment credit, you borrow a set amount of money upfront. Then, you make monthly payments to pay back that set amount of debt, plus interest. Your payment amounts won’t change unless you refinance, even as you get closer to paying off your debt.
Revolving credit and installment credit affect your credit score in different ways. With revolving credit, a portion of your score is calculated based on how much of the total credit you have available versus how much you’ve used. But this isn’t the case with installment credit. While a large amount of installment credit will cause your score to drop at first, this trend won’t continue.
How Much Will Your Credit Score Drop?
There is no set ratio for how much your credit score will drop versus the total of your mortgage. Instead, the drop will be based on your current score, your mortgage, and a variety of other factors. However, in most cases, your credit score will drop by just 15 to 40 points when you are approved for a mortgage.
In addition to that drop, your score may also drop as a result of lenders pulling your credit when you apply for a mortgage. If you shop around for the best mortgage rate, your score may drop even more. On average, your score will drop by 5 points for each hard pull on your credit by a lender.
Make Regular Mortgage Payments and Watch Your Score Rise
The good news is that while your credit score will take a hit when you buy a home, with a little work, this will soon reverse. Making your mortgage payments in full and on time each month will allow your score to begin to climb back up to pre-mortgage levels, and perhaps even exceed them.
It takes around 5 months for your score to begin to rise after buying a home, assuming that you’re making your payments.
Avoid These Mistakes That Can Drop Your Score
After your credit score has already taken a hit from your home purchase, the last thing you want to do is cause it to drop further.
The best thing that you can do is to make your mortgage payments on time each month and make sure to pay them in full. Of course, other smart credit moves like paying down credit card debts, never missing payments, and avoiding closing out old accounts will also help.
While it will still hurt your credit score no matter when you do so, you might want to rethink making big purchases like a new car within 6 months to a year of buying a home. Because your score is lower as a result of your new mortgage, you may not qualify for as good of an interest rate. If you can, wait to make that big purchase when your credit score has had a chance to recover. That way you can take on less debt, and continue working to improve your credit score and your financial future.
Buying Your First Home
A drop in your credit score shouldn’t be a reason not to buy your first home. If you’ve worked hard to get to a place where you can purchase your first home, the small hit to your score is well worth it. After you’ve moved in, continue making smart financial moves, and never miss a mortgage payment, and you’ll soon be well on your way to reversing the damage.
Are your finances not quite ready for buying a home? We can help! Check out this Savings Guide next to learn what you need to know to start saving up to purchase your first home.