Why Taking Out A Mortgage Can Temporarily Give Your Credit A Hit, And Why It Gets Better
For many, it comes as a surprise that having taken out a mortgage, they then experience a dip in their credit score, especially after so many have worked hard to improve their score to be accepted for a mortgage.
While such a dip can be alarming, it is nothing to worry about. The score should recover, and in this article we examine the process involved, and the long-term benefits of a mortgage.
A Breakdown Of FICO Credit Scores
Before we examine why mortgages affect credit scores, it is necessary to comprehend how scores are calculated. The truth is, that an individual’s score with each of the credit bureaus is always determined by various factors that contribute in different amounts to your score.
This is how your FICO score is broken down:
Payment History (35%)
The single biggest factor is your history of making payments on time. This is why it is crucial not to miss payments on any finance.
Credit Utilization Rate (30%)
The next most important factor refers to the proportion of an individual’s total credit available to them that has been used. It is usually referenced as a percentage.
For example, if you have 2 credit cards each with a $5,000 credit limit, and have a $2,500 balance on each, your utilization rate is 50%.
Prospective lenders do not take kindly to those that have “maxed out” every line of credit they have. This gives the impression of someone that is struggling to get by, casting doubt that repayments will be made. For an optimum credit score, it is advised to keep the utilization rate to under 30%. It does not help to be at 0% however, as lenders want to see evidence of repayments being made.
Credit History (15%)
A factor that is out of your hands and requires patience if you need it to improve your score. The longer a person has had financial accounts, the more this can help improve a credit score. Like a fine wine, credit scores often improve with age.
A FICO score will consider how long accounts have been open, the age of the oldest and newest accounts, while also calculating an average age for all accounts. It may also look at how long it has been since certain accounts have been utilized.
Credit Mix (10%)
It will be taken into account not only how much debt you have, but where that debt lies. A FICO score favors those that have a variety of debt rather than one type.
It can help your score to hold debt through an installment loan, credit card and mortgage for example, if repayments are being made on time. Lenders like that you can handle a mixture of debt. They will see you as low risk for their products, though as credit mix only accounts for 10% of your score, it is not essential to vary your debt.
Why A Mortgage Can Dent Your Credit Scores
The factors mentioned previously give hints as to why taking out a mortgage can see a credit score take a short-term dip as a consequence. Let us examine the events that cause it to happen:
- Applications for credit usually cause a credit score to lower because the lender, by checking out a person’s credit score, carries out a “hard pull”. Each pull lowers a score. The pull remains on a record for two years. A mortgage application may include two pulls, one when the initial loan application is made, and the other just before it is issued.
- Opening a new account can also lower a score, often because it increases debt in doing so. If the pre-existing debt was low, then this sudden huge rise can have negative consequences.
Why A Mortgage Could Help Your Credit Scores In The Long Run
The good news is that any drop in your credit score after taking out a mortgage should be short-lived. In fact, in the long-term a mortgage should help your credit score improve, due to the following factors:
- Greater Payment History – As long as regular payments are made on the mortgage, your credit score should rebound quickly, and adding a mortgage to your payment history is beneficial to your report over time.
- Reduction Of Debt – As you make your mortgage payments, naturally what you owe on your property reduces with each passing month. As your debt reduces, so your credit score should improve gradually to reflect this change.
- Superior Credit Mix – By taking on a mortgage, which presumably was not previously a form of credit, your mix of credit becomes more varied, helping your credit mix score with such diversity.
Taking out a mortgage will inevitably cause a dip in your credit score but there is no cause for alarm, as such a dip should be short-term only. By making regular payments on your mortgage, your credit score should not only recover but eventually be better than before.