How a Mortgage Can Help (or Hurt) Your Credit

Will a mortgage help — or hurt — your credit? If you’re thinking, “Well, both,” you’re exactly right. But there are subtleties involved that may surprise you.

To get a mortgage these days, a lender is going to closely scrutinize your income, debt, and credit history before giving you the loan. That makes a mortgage a sign of financial responsibility that can help your credit scores, says Sarah Davies, senior vice president, risk and analytics, for VantageScore. “They see you as a highly creditworthy consumer,” she says.

“You might notice that most credit reports single out mortgages in their own category, separate from installment loans and revolving loans,” Steve Ely, CEO of eCredable points out. “Lenders looking beyond the credit score want to quickly see how well you’re doing living up to this obligation. For example, if you are responsible enough to take on a mortgage, and can make the ongoing payments on time, you are rewarded by having your credit score increased over time.”

Another way a mortgage can help your credit is by rounding out your credit history. “Over the long term, adding a mortgage to your credit report can improve your credit “mix” if, for example, your credit report only contains revolving (typically credit card) accounts,” explains Barry Paperno, community director for Credit.com and an expert in credit scoring. “Having multiple types of credit — revolving and installment — indicates you’re able to manage different types of credit products, and leads to lower risk.”

But that’s not a huge advantage he warns, since only about 10% of your score is based on your mix of credit. (He’s talking primarily about FICO scoring models here.) “Don’t expect the addition of a mortgage to add more than a few points to your score even under the best of circumstances.”

What about homeowners who have paid off their mortgages? While that may be the smart thing to do financially, it’s not likely to mean a boost to your credit scores. While a paid-off mortgage is still considered when your credit scores are calculated, “it doesn’t play as significant a role,” as one that is still in repayment, Davies warns. One reason for that is that the scoring model can’t tell if the homeowner paid the loan off or simply refinanced it.

And what about the size of the loan? Is it better to have a larger mortgage? That may help a little bit, Davies says. But by the same token if you fall behind, the hit to your scores can be greater.

And, yes, a mortgage can also hurt your credit. The millions of Americans who have missed payments or lost their homes to foreclosure in recent years know that firsthand. Miss a mortgage payment and your scores may drop significantly.

A VantageScore report explains it this way: For most credit card models, missing a credit card payment has less impact than missing a mortgage or auto payment. This is because credit score models consider late payments on your larger, secured debts as higher risk than being late on smaller, unsecured debts such as credit cards.

“The bigger the asset, the more foundational it is, and the bigger the hit to your credit score,” warns Davies.

But even if you’ve made all your payments on time, there is another way a mortgage can impact your credit scores. It’s due to the way new accounts impact your scores. Paperno explains:

The immediate impact upon adding a mortgage (or any new account) to your credit report is usually a drop in your score. Research has shown that a consumer who has opened a new account recently is more likely to have problems paying on time in the future than someone who has no recently opened accounts. Fortunately, any points lost for this reason tend to be regained within six months after opening the new account, provided all payments are made on time, account balances are kept low and additional new accounts are opened only as needed.

Ultimately, like most types of credit, a mortgage can help your credit if you manage it well and make the payments on time. That may be easier said than done for some these days, but if your goal is a strong credit score, it’s worth keeping in mind.

Image: Caitlin Childs, via Flickr