How Buying a Home Affects Your Credit

Taking on a mortgage, especially as a first-time homebuyer, can be intimidating. Finding out that it can lower your credit score can be downright stressful. It’s a bit of a “Catch 22”: You need good credit to buy a house, but buying a house lowers your credit. 

Buying a home affects your credit in both good and bad ways. Once you endure the initial setback of a dip in your credit score, having a mortgage can actually turn into one of the biggest advantages for your credit. 

Unfortunately, this is true—at least at first. Let’s suppose someone is applying for a mortgage. (More about how to qualify in the next section.) As part of the application process, the lender will do what’s called a hard credit inquiry. This means they will pull credit data and check the credit score. 

A lender checking credit data signals that the individual is about to get a mortgage, which is one of the biggest pieces of debt most people will ever have. Just applying for the home loan can cause a drop of a point or two in the credit score.

Now let’s say the bank has approved the loan. It is not uncommon for new home buyers to see their credit score drop by 15, 20, or even as much as 40 points! The amount of the drop depends on the homebuyer’s perceived ability to pay the debt. If the credit score isn’t great to begin with, taking on a huge amount of debt compared to income will increase the impact.

It might seem unfair to be penalized for doing a grown-up and responsible thing like buying a house. But look at it from the lender’s perspective. Someone with a few credit cards that get paid off each month, plus a few thousand dollars owed on a car note, is suddenly responsible for a home loan for hundreds of thousands of dollars.

Especially if this is a first home purchase, that individual’s credit landscape has now changed drastically. Until the homeowner proves they can pay the debt, they will be seen as a risk, and that fact will be reflected in the credit score. The good news is that the credit score can bounce back, making their credit even stronger than before.

Getting a mortgage is all about showing a lender that you’re a good risk. To find out if someone is responsible enough to loan money to, lenders use a person’s credit score. There are three credit reporting firms that calculate these scores: Equifax, TransUnion, and Experian. 

A credit score of 700 or better (the scale goes up to 850) is usually necessary to secure a conventional fixed-rate mortgage. If the borrower qualifies for an FHA or VA loan, they can get by with something as low as 500. 

The higher the credit score, the better the terms of the mortgage. Low scores might indicate that an applicant doesn’t have a good track record of paying their bills on time or that they have an abundance of credit card debt. This will raise concerns for the bank about getting their investment back. Banks make up for taking on this risk by charging higher interest rates or insisting on, for example, a 30-year instead of a 15-year mortgage.

People with bad credit and a score of less than 500 may still be able to get a home loan. These are known as subprime loans and may come with very high interest rates and additional fees. 

The criteria used by the three credit reporting companies to calculate credit scores are:

• How good the applicant is at making payments on time.
• The overall debt burden made up of all credit cards, auto and personal loans, and even leases if they rent.
• Credit mix. Someone with a few credit cards and a car loan will typically score better than someone with only one credit card.
• Age of credit accounts. A brand new credit card account won’t help as much as one that’s been open for several years.

When someone is taking on a mortgage, it’s important to keep an eye on their debt-to-income ratio. In basic terms, this means making sure that the money earned each month is enough to cover debt payments and all living expenses. Unfortunately, people can sometimes be unrealistic about what they can afford, or unforeseen circumstances can make it difficult to keep up with the bills. Missing mortgage payments can seriously damage credit.

Following these steps can help a credit score recover from the initial hit it takes when buying a home. 

1. Do everything possible to build up a credit score before applying for a mortgage. A good credit score can result in a lower interest rate, which in turn means a lower monthly mortgage payment. Over time, the savings will be significant.
2. Be sure to pay the mortgage in full and on time. A late or skipped mortgage payment is far worse for the credit score than a late credit card payment.
3. Hold off on signing up for new credit cards or getting additional loans. Whether it’s new furniture or remodeling and repairs, it’s tempting to spend money after buying a new home. Wait for the credit score to rebound before applying for any additional credit. 
4. Don’t max out current credit cards on things for the new house. Paying those bills, on top of the new mortgage, can be a struggle. Late payments or paying only the minimum amount will increase debt and strike another blow to the credit score.
5. Don’t assume that paying off the mortgage (if possible) is best. In some cases, steady monthly payments will do more for a credit score than getting rid of the loan altogether. Check with an accountant or financial advisor for advice if this is an option.

If you’ve taken the time and effort to build up your credit score, it can be frustrating to see it fall when you buy a house. But if you’re careful about your finances, it shouldn’t impact your decision to become a homeowner. A short-term drop in your credit score can be followed by the long-term benefits of good credit.