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How does a mortgage affect your credit score?

Your credit score can be a key determinant of whether you are accepted or rejected for a mortgage application. There are very few people who can afford to buy a property with 100% cash, and therefore your credit score will allow a lender to decipher how risky you may be as a potential customer.

However, your credit score before taking on your mortgage isn’t the only important thing. The mortgage itself can greatly impact your credit score. Assuming you make all of your payments on time as agreed within your mortgage terms, your mortgage is likely to have a nice boost to your credit score.

Improved Credit History

One of your credit score’s key determinants and your viability as a lendee is your credit history. Nothing impacts your credit score more than the history of payments you have made against the borrowed money.

Your typical mortgage will likely have an amortization period of 15 to 30 years, which means you will be making a lot of credit-related payments in that time. If all of your payments are on time during this period, then it can really improve your credit score. Another factor is your credit age; because you will show yourself able to pay amounts against your mortgage consistently over a long timeframe, it will help.

However, it is worth noting that missing payments can be detrimental to your credit score, even if it is just a single payment missed. One missed payment could ruin the benefits of 30 years of on-time payments that you have made.

Diversified Credit

Another factor that builds into your credit score is the number of different credit types you have obtained during your credit history. There are many different credit applications you can make – whether it be credit cards, car loans, mortgages, and more. Having a wide variety of these types of loans can improve your credit score. However, even with the most diversified credit history possible, you cannot out-weigh a history of missing payments.

These types of loans are viewed as different types of credit, from a credit card which is a revolving credit loan, and a mortgage is an installment loan. Having these different types of loans shows diversity to pay back against credit no matter the setup.

How a Mortgage Differs to Rent

The key difference between a mortgage and rent when it comes to your credit score is that rental payments are not a form of credit. In this instance, the property’s landlord is not lending you anything you are making repayments against. Renting is essentially a service at its core. You’re paying someone for the service of living on their property. On the other hand, a mortgage is an act of receiving a lump sum of money to put towards a property that you will buy, and then you will repay against that credit, therefore improving your credit score (assuming payments are made on time).

There is a way rental payments can be considered in a credit scoring model, but they require reporting via rent reporting services. However, this isn’t that common, and unlike a mortgage which will be automatically reported to the credit bureaus, getting rental history into your credit score isn’t a straightforward process.

Negative impact of a Mortgage

As we have discussed, a mortgage will build your credit over time if you are making your payments accurately and on time. However, taking out a mortgage can also reduce your credit score at first.

When you decide to apply for your mortgage, the lender you have chosen will perform a credit check to read through your credit report and conclude whether you’re suitable for approval. The credit report will trigger what is called a ‘hard credit inquiry. The act of running off this report can temporarily lower your credit score by a few points. It is important not to apply for too much credit in a short period of time, as all of the lenders will be running this report, and it could show badly on your credit history. However, FICO produces the credit scores, has something in place that does not count multiple inquiries within a 45 day period, so multiple mortgage inquiries should not significantly impact your credit score.

The standard approach to these credit reports is for the lender to take the three most common major credit bureaus reports. They will then either take an average of the three scores or choose the middle score to determine whether they will accept you or not and what rate they will offer. If you choose to take a look at your credit score/report (which you can do for free), you will be able to see the history of the inquiries made by lenders over time.

In conclusion, the key takeaways here are that taking out a mortgage from your lender may temporarily negatively impact your credit score up until the point you can prove your ability to pay back the loan. To consistently improve your credit score entails consistently making payments on time throughout the history of your mortgage. On top of that, your mortgage will help your credit score by improving the mix of a diversity of debt that you have taken on.

As long as you make your mortgage payments on time, you will reap the positive benefits of taking on a mortgage in the eyes of the credit bureaus. If you miss a payment, there are credit repair companies out there who can advise on the best course of action.

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