There are several potential ways a new mortgage can impact your credit score, some good and some bad. Here's an overview of the five categories of credit-scoring information and how your new mortgage might affect each one.
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Where your FICO credit score comes from
Before I can answer the question of how a mortgage will affect your credit score, it's important to briefly discuss where your credit score comes from.
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When I use the term "credit score," I'm referring to the FICO score, which is by far the most common scoring model used by lenders. And while the exact FICO scoring formula is a closely guarded secret, we do know the categories of information that make up your score, as well as how heavily each one is weighted.
- 35% of your score comes from your payment history -- that is, do you pay your bills on time, every month?
- 30% of your score comes from "amounts owed." Not only does this refer to the actual dollar amounts you owe, but the amounts you owe relative to your credit limits and original loan balances, among other balance-related information.
- 15% of your score comes from "length of credit history," which includes several time-related metrics. The age of your oldest credit account, the average age of all your accounts, and the age of each individual account on your credit report are all taken into consideration.
- 10% of your score comes from your new credit. This includes newly opened credit accounts, as well as credit that you've applied for, even if you didn't end up borrowing any money or opening a new account.
- 10% of your score comes from your credit mix. Simply put, lenders want to see that you can handle all types of credit responsibly, not just one or two. If you have several account types, such as a mortgage, auto loan, line of credit, and a credit card, it can have a positive effect on your score.
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Possible negative impacts of a new mortgage
Based on the FICO scoring method, there are certainly some ways your score could be negatively impacted by opening a new mortgage.
The mortgage application itself adds a credit application (inquiry) to the "new credit" category, and after you obtain the loan, it counts as a new account. However, keep in mind that only inquiries from the past year are considered in your credit score, so this impact won't last too long. It's also worth mentioning that there's a special rule in the FICO formula that says if you apply for more than one mortgage in a short (two-week) time frame, say, to shop around for the lowest interest rate, it will count as a single inquiry for scoring purposes. So, don't hesitate to shop around.
Similarly, the new mortgage could hurt your "length of credit history" category as well. Even so, this impact is likely to be short-lived. As time goes on, it will look like less of a "new account."
Positive impacts of a mortgage
Unfortunately, the immediate impact of a mortgage can be negative. The good news is that over the long run, your mortgage is likely to be an overwhelmingly positive catalyst to your credit score, and will help all five categories of your FICO score.
Provided that you pay your mortgage on time each month, the payment history category will take care of itself. And, as time goes on, you'll owe less on your mortgage relative to the original amount you borrowed.
Additionally, in time, your mortgage will be a positive factor in the "length of credit history" category, and won't be a drag on the new credit portion of your score.
Finally, your mortgage could have an immediate impact on the "credit mix" category, especially if you didn't have a mortgage previously.
The likely scenario
Without knowing your personal credit profile and the exact FICO formula, it's impossible to say for sure exactly how your credit score will be impacted by getting a new mortgage.
Having said that, I've bought three homes in my lifetime, and all three times, my credit score dropped initially by about 20 points and gradually began to rise after a couple of months. In every case, my credit score one year after getting a mortgage was higher than it was before I got it. This outcome makes sense, given the negative and positive factors discussed earlier.
Therefore, the most likely impact on your credit score when you get a mortgage will be a small drop at first, if anything. Then, over time, the positive factors will outweigh the negatives and most likely boost your credit score, as long as you pay on time every month.
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