How Your Mortgage Affects Your Credit and Vice Versa
Here’s what you need to know about credit when shopping for a home.
The Effect of Mortgage Applications and Inquiries
When you apply for a loan or for a line of credit, your credit score usually takes a small hit. Luckily, you don’t have to be too worried about dinging your credit score when you go loan shopping.
Normally, multiple credit inquiries would indicate a problem with your credit or that you have a problem with debt. However, loans such as mortgage and auto loans have a grace period during which multiple inquiries are treated as a single inquiry, so you don’t have to worry about your credit taking a dive.
While your lender will probably pull your FICO score, which has a 30-day grace period, they may instead pull your VantageScore—which only has a 14-day grace period.
To be on the safe side, do all of your loan shopping within seven to ten days.
What Mortgage Lenders Look for in Credit Scores
Lenders are looking for good credit scores and the absence of bad credit marks, such as these:
§ Defaults in payment
Payment history is the greatest factor in your FICO credit score, accounting for 35% of the score. The other FICO credit factors are amounts owed (30%), length of credit (15%), new credit (10%) and types of credit (10%).
Loan Balances and Debt-to-Income Ratios
The balance of your home loan influences your credit positively as the loan decreases. Your credit score gets better as the gap between your original loan and current balance diminishes.
Your debt-to-income ratio compares all your debts, loans and credit cards to your total income. A high debt-to-income ratio could result in the denial of a loan. A low debt-to-income ratio shows lenders you have a better ability to repay the loan and is preferred by lenders.
Some loans, like qualified mortgages, require the borrower to have less than a 43% debt-to-income ratio to be eligible as a borrower.
Managing Your Credit Score
Getting and maintaining a good credit score may not be easy, but there are steps you can take to keep a healthy score:
§ Offer a higher down payment so you are borrowing less money.
§ Do not apply for any new loans or lines of credit during the home-buying process.
§ Lower your debt-to-income ratio by paying off as much debt as possible before applying for more credit or a mortgage.
§ Make all payments on time.
Sometimes credit reports may misreport negative events—like late payments, lawsuits, liens, bankruptcies, repossessions and foreclosures—so monitor your credit report every few months. Dispute any claims that don’t look right.
By law, you are granted one free credit report from each of the three credit agencies (Equifax, TransUnion, Experian) every year. Go to annualcreditreport.com to get yours.
Updated from an earlier version by Frank Alan Herch.