Despite higher prices and stubborn mortgage rates, the American dream of owning a home is still prevalent today. Buying a home is still regarded as a wonderful investment in one’s future.
Two questions young prospective homebuyers often ask are “What credit score is needed to buy a home?” and “How many points will a mortgage raise your credit score?”
What is the Highest Credit Score You Can Get?
Credit scores can vary from month to month. The highest possible credit score is 850 and the lowest is 300. Here is the breakdown of scores:
Exceptional: 800-850
Very Good: 740-799
Good: 670-730
Fair: 580-669
Poor: Below 580
According to Experian, the average credit score is 715 and most Americans have a score between 600 and 750. A good credit history shows loans and credit card payments being made on time and, in some cases, satisfactorily paid in full. A bad credit history might include late payments, stopping payments, charge-offs and a high utilization rate on current credit cards.
You don’t need a perfect credit score to apply for a mortgage. And over time, having a mortgage may even raise your credit score. However, increases in credit score points depend on several factors:
Credit scoring systems are typically computed by Fair Isaac Corp (NYSE: FICO) and are a tool that lenders use to assess a person’s risk for qualification for a loan, credit card or mortgage. A mortgage credit score is a FICO score used by lenders to determine a borrower's creditworthiness. Consumers can check their credit reports once a year for free at any of the three major credit bureaus.
Taking out a mortgage won’t immediately boost your credit score and could temporarily lower it by 5-10 points since the credit report the lender pulls is considered a hard inquiry and you are taking on increased debt.
However, making a mortgage payment on time for just one or two years can boost your credit score. A mortgage is an installment loan, meaning you receive a lump sum to buy a home and are then mandated to repay it in a series of fixed amounts over a set number of years. The home is the collateral for the mortgage, so failure to make payments on the loan could result in a foreclosure. Even being late with a payment once or twice can cause a decline in the credit score.
Ironically, the negative impact of missing a mortgage payment is greater for those with higher credit scores. Furthermore, missed payments can remain on a credit report for up to seven years.
A mortgage is considered an installment loan and is an important part of one’s credit score and history. 35% of your credit score is your payment history, so making on-time payments is crucial to increase your score. The easiest way to make on-time payments is to set up an automatic bank draft that sends the payment to the mortgage lender before it’s due. Some lenders may even offer a small discount for automatic payments.
Adding other types of accounts to a mortgage can create a credit mix, which makes up another 10% of your overall credit score. If one has a retail account or a revolving credit account, such as a credit card, adding an installment loan such as a mortgage creates a mix of accounts that will lift a credit score.
Credit Utilization Ratio
The amount of credit you use on a revolving account, such as a credit card, compared with the total available revolving credit is called the “credit utilization ratio.” Suppose you have $2,000 in credit card charges and the credit card limit is $10,000. Your credit utilization ratio would be $2,000 divided by $10,000 or 20%. The credit utilization ratio makes up another 30% of the credit score. The best way to improve one’s utilization ratio is to pay down or off credit cards.
Credit cards are wonderful conveniences but can get people into trouble if the cards are not used responsibly.
However, since a mortgage is an installment loan, it has little effect on the credit utilization ratio. The best way to improve one’s credit score is to keep their credit utilization ratio as low as possible.
Finding A Mortgage Lender
There are thousands of mortgage lenders today, so consult sources that advise finding the best one for your particular situation.
There are also reviews on mortgage lenders that will help you decide which one to choose.
Some people like to shop for the best interest rate among different mortgage lenders. At one time, this could negatively affect one’s credit score because frequent credit score pulls made it seem like the applicant had received frequent denials. FICO would regard this person as a higher credit risk. Consumers had little clue they were hurting themselves by allowing multiple sources to pull their credit history.
However, in recent years, FICO scoring models have changed so that if a consumer has more than one credit pull for a mortgage over a short time, only one credit pull is counted against the score. Depending on the FICO scoring model a lender uses, this time frame can vary from two weeks to 45 days, so it’s a good idea to ask the lender which version they use. There is no harm in comparing mortgage rates and fees as well. FICO scores only consider inquiries over the past 12 months even though inquiries stay on one’s credit report for 24 months.
However, when applying for a mortgage, if one also has recent credit pulls for nonmortgage financing, such as a car, boat, personal loan or school loan, that can adversely affect one’s credit score. Taking on extra loans can also harm someone’s debt-to-income ratio, a measure that mortgage lenders use to assess if a homebuyer’s other debt will hinder the ability to pay the mortgage.
Soft inquiries do not affect one’s credit score for home loans. One example of a soft inquiry is if an individual pulls their credit history from one of the three credit bureaus.
Required Credit Scores For Home Loans
The higher one’s credit score, the lower the mortgage interest rate they will receive. There are several types of mortgages, including Conventional, FHA, VA and USDA. Conventional mortgages generally require a minimum of 5% down, but this percentage varies with economic conditions. Years ago, Conventional loans required 20% down, but this has declined over the years.
Conventional loans usually have the best interest rates and terms, but the minimum credit score requirement is 620 and some lenders require 660 or higher. A credit score of 740 or higher will qualify for the lowest interest rates and down payment amount. However, if a borrower with a 740 credit score puts down 20%, they can get a half-point lower rate than a buyer with a 640 credit score.
Federal Housing Administration (FHA) loans require a credit score of 580 or better to qualify. One advantage of an FHA loan is the minimum down payment of 3.5%. Yet, because of the low down payment, one must pay an upfront Mortgage Insurance Premium (MIP) of 1.75% of the loan amount, plus a premium added to the monthly payments. MIP cannot be canceled unless the borrower puts down 10% or more.
Credit History
Credit history is an important part of a credit score and includes loans and revolving lines of credit that a borrower has or has not paid in the past. A long and strong credit history of paying bills and loans on time assures the mortgage lender that the risk of default is low. Conversely, a poor credit history lowers one’s overall score and suggests that the person is at a higher risk of mortgage default. This is why lower credit scores require a higher mortgage interest rate.
Some younger people who want to buy a home may think they can’t because they have no credit history. It’s true that without a credit history, one cannot secure a conventional loan. However, FHA does not require a credit history. FHA believes lending to someone with no credit history is less risky than lending to those with poor credit histories.
Research On How Much A Mortgage Can Increase Credit Scores
A borrower’s credit score should rise after a year or more of on-time mortgage payments. The specific number of points gained will depend on previous credit history, total debt, credit utilization ratio and length of credit history. The lower one’s score before getting the mortgage, the greater the increase gained from making timely payments.
In a recent study by Fannie Mae and Freddie Mac, one million mortgages originated between 2009-2023 were analyzed for their effect on credit scores. The average increase in FICO score for those who never missed a payment when compared with the FICO score at the time of loan origination was 7.68 points.
However, there was a performance disparity, depending on the loan’s length. Mortgages with longer payment histories improved FICO scores by 20 to 35 points. Loan terms of five years or less ranged from a loss of 4.81 to a gain of 9.74 points.
Fannie Mae also found that those with the highest FICO scores who had one delinquency within the first 12 months had a decreased FICO score between 20.31 and 34.91 points.
So, there is not simply one answer to the question, “How Many Points Will a Mortgage Raise Your Credit Score?” It varies from person to person and depends upon each person’s length of time making mortgage payments, credit history, credit mix, credit utilization ratio, number of open accounts, etc. A mortgage application can positively impact a person’s financial profile if it shows a history of paying bills on time.
Ironically, paying off a mortgage can lower your credit score because you no longer have the credit mix that FICO likes to see and the average age of your existing accounts, which accounts for 15% of one’s credit score, declines. But the dip in score is slight, perhaps 20-25 points and certainly less than one would receive for missing a payment or more.
However, the one point that the credit bureaus and financial experts agree on is that making regular, on-time mortgage payments establishes an excellent credit history and will over time enhance one’s credit score.