Before you make a major purchase, like a home or car, you’ve probably put a lot of thought into the process. You might have worked to make sure your credit is in the best shape possible before you apply for a loan. Perhaps you’ve shopped around and compared interest rates to make sure you’re getting the best deal available on financing.
Yet there’s one factor that many borrowers forget to consider before taking out a large loan–the impact it will have on your credit score.
Why a Big Purchase Might Harm Your Credit Score
A recent study found that in the six months after getting a mortgage, credit scores may fall by about 20 points on average across the nation’s 50 largest metros. However, most borrowers also saw their credit scores rebound to their pre-loan starting points in less than a year.
According to Jacob Channel, senior economic analyst for LendingTree, the credit score change occurs because adding a new account with a large balance to your credit report increases your credit risk.
“Taking out a new mortgage usually causes a person’s score to decrease as it adds a large new balance to their credit report that they haven’t yet proven their ability to pay off,” says Channel. He adds that the combination of a larger debt and lack of evidence that the consumer can manage the new account may lead to more risk in the eyes of lenders and, in turn, lower credit scores as a result.
According to credit scoring firm FICO®, even refinancing a large loan could potentially impact your credit score in a negative way (though that’s not always the case).
Additional Credit Score Factors
Credit reporting agency Experian explains two additional reasons why a new mortgage might lower your credit score:
- A new loan will decrease your average age of credit (a factor, among others, that influences 15% of your FICO® Score).
- The new hard credit inquiry from the mortgage might have a negative credit score impact as well, though this typically isn’t significant.
Credit Score Recovery Can Take Time
Seeing your credit score drop after a major purchase can be frustrating, especially if you have plans to apply for other financing. Unfortunately, the credit score recovery cycle takes around 339 days on average.
Channel says that borrowers need time to prove to lenders that they’re able to handle their new debt, noting that “one of the main ways to do this is to make multiple, one-time payments, which is a time-consuming process.”
It’s also important to consider the fact that there are delays between when a borrower makes a payment and when that payment actually shows up on their credit report. Because of this phenomenon, credit scores might remain low for a while even after the borrower has made several on-time loan payments.
As Experian points out, your credit score will only change when information on your credit report updates.
How to Rebuild Your Credit Score after a Decline
Smart credit moves after taking out a new mortgage have the potential to help you rebuild your credit score–perhaps even faster than average.
Channel notes that the best step you can take toward better credit after a mortgage is to pay your credit obligations on time. That advice applies not just to your new mortgage loan, but to your other debts as well.
“The more payments a borrower makes on time, the less risky they’ll appear to lenders and the higher their score will be,” he says.
In addition to on-time payments, you might consider paying down any outstanding credit card balances you owe. Credit utilization–the connection between your credit card limits and balances–can have a significant impact on your credit score.
As you pay down your credit card debt, your utilization rate should go down. That reduction can have a positive impact on your credit score.
Debt consolidation is one strategy that some people use to lower their credit utilization levels when they can’t pay off all of their credit card debt at once. The approach can be helpful in many situations, as long as you can avoid running up new balances on your original credit cards after you pay them off with a consolidation loan or balance transfer.
If you’re planning to make a major purchase, it’s in your best interest to make sure your credit is in good shape. The higher your credit score, the better your approval odds may be, and you could even secure better interest rates and terms, too.
Channel adds that good credit can also work in your favor after you close on a new loan.
“The stronger a borrower’s initial credit score, the less damage something like a new mortgage is likely to do,” he says. “As a result, borrowers who work hard to boost their scores before they get a mortgage can usually better avoid some of the drawbacks a drop in their credit score could bring.”
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