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How Does Paying Off Your Mortgage Affect Your Credit Score?

February 27, 2019

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A mortgage is probably the largest debt you’ll ever have, and paying it off is a significant achievement. But credit bureaus like Equifax, Experian, and TransUnion might not be as thrilled.

“Paying off any debt will certainly affect your credit score, and your mortgage is no exception,” says Michael Mesa, branch manager and certified mortgage planning specialist at Fairway Independent Mortgage Corp in Lacey, WA.

Depending on various factors, this act of financial responsibility could increase or decrease your credit score.

How does paying off your mortgage affect your credit score?

It’s hard to pin a credit score number on the effects of paying off your mortgage.

“The first thing to remember is that the formulas for computing credit score are proprietary, so we are making educated guesses at the effects of any one item on a person’s credit score,” says James Philpot, a certified financial planner and associate professor of finance and general business at Missouri State University.

“The second thing to remember is that when we try to answer questions like ‘What is the effect of X on my credit score,’ we are assuming that we are comparing two credit customers who are identical in all respects except the variable in question—and this is almost never the case,” he adds.

Your credit score could decrease

As crazy as it seems, paying off what is likely your largest installment debt might not, in fact, send your FICO score through the roof.

Philpot explains that if you don’t have a balanced mix of revolving to installment debt and a good length of time that credit has been established—and is still open—your score may dip slightly.

“While minor, there could be a negative impact if your mortgage was the only loan in the installment category, as the overall credit mix of your credit picture accounts for 10% of your score,” says David Bakke at MoneyCrashers.

And credit type isn’t the only category that could negatively affect your score.

“Your score may also see a modest drop when the loan is paid off, because it takes the mortgage off of the length of credit portion of your score, which accounts for 15% of your score,” Bakke says.

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Watch: How to Get the Best Mortgage Interest Rate You Possibly Can

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So, if your mortgage is your only installment loan, you might want to reconsider paying it off.

“It may be better for your credit score in the long run if you keep your installment loan open for its full term while continuing to make regular, timely payments,” says Theresa Williams-Barrett, vice president of consumer loans and loan administration at Affinity Federal Credit Union.

Your credit score could increase

On the other hand, paying off your mortgage might boost your credit score.

“If you do have other debt that you’re paying on every month and showing creditors that you are a responsible borrower, paying off your mortgage may show as a positive because your debt-to-income ratio may be higher,” says Michael Foguth, founder of Foguth Financial Group in Brighton, MI.

Also, there is a basic credit advantage to paying off such a large amount.

“As a general rule, borrowers who have less debt already outstanding are considered to be better credit risks,” says Philpot. “Also, no longer having to make a payment will improve your net monthly cash flow, increasing capacity to make new payments.”

For example, whenever you apply for a loan, creditors want to know how much debt you already have. Moving a mortgage off your plate significantly reduces your total debt amount, which can make you more attractive to creditors.

Before you pay off your mortgage

Before making any big financial moves, find out what’s involved in paying off your mortgage.

“Clarify with your lending institution if there are any prepayment penalties,” says Williams-Barrett.

Also, make sure you have a nice savings cushion before paying more on your mortgage.

“It’s important to save those would-be extra mortgage payments for emergencies, even if it means avoiding a year or two of interest payments,” Williams-Barrett says.

The post How Does Paying Off Your Mortgage Affect Your Credit Score? appeared first on Real Estate News & Insights | realtor.com®.

What Is a Good Credit Score to Buy a House?

February 12, 2019

If you’re hoping to buy a home, one number you’ll want to get to know well is your credit score. Also called a credit rating or FICO score (named after the company that created it, the Fair Isaac Corporation), this three-digit number is a numerical representation of your credit report, which outlines your history of paying off debts.

Why does your credit score matter? Because when you apply for a mortgage to buy a home, lenders want some reassurance a borrower will repay them later! One way they assess this is to check your creditworthiness by scrutinizing your credit report and score carefully. A high FICO rating proves you have reliably paid off past debts, whether they’re from a credit card or college loan. (Insurance companies also use more targeted, industry-specific FICO credit scores to gauge whom they should insure.)

In short, this score matters. It can help you qualify for a home, a car loan, and so much more. Which brings us to an important question: What type of score is best to buy a house?

Inside your credit score: How does it stack up?

A credit score can range from 300 to 850, with 850 being a perfect credit score. While each creditor might have subtle differences in what they deem a good or great score, in general an excellent credit score is anything from 750 to 850. A good credit score is from 700 to 749; a fair credit score, 650 to 699. A credit score lower than 650 is deemed poor, meaning your credit history has had some rough patches.

While FICO score requirements will vary from lender to lender, generally a good or excellent credit score means you’ll have little trouble if you hope to score a home loan. Lenders will want the business of home buyers with good credit, and may try to entice them to sign on with them by offering loans with the lowest interest rates, says Richard Redmond at All California Mortgage in Larkspur and author of “Mortgages: The Insider’s Guide.”

Since a lower credit score means a borrower has had some late payments or other dings on their credit report, a lender may see this consumer as more likely to default on their home loan. All that said, a low credit score doesn’t necessarily mean you can’t score a loan, but it may be tough. They may still give you a mortgage, but it may be a subprime loan with a higher interest rate, says Bill Hardekopf, a credit expert at LowCards.com.

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Watch: What Is the Best Credit Score to Buy a House?

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How a score is calculated

Credit scores are calculated by three major U.S. credit bureaus: ExperianEquifax, and TransUnion. All three credit-reporting agency scores should be roughly similar, although each pulls from slightly different sources. For instance, Experian looks at rent payments. TransUnion checks out your employment history. These reports are extremely detailed—for instance, if you paid a car loan bill late five years ago, an Experian report can pinpoint the exact month that happened. By and large, here are the main variables that the credit bureaus use to determine a consumer credit score, and to what degree:

  • Payment history (35%): This is whether you’ve made debt payments on time. If you’ve never missed a payment, a 30-day delinquency can cause as much as a 90- to 110-point drop in your score.
  • Debt-to-credit utilization (30%): This is how much debt a consumer has accumulated on their credit card accounts, divided by the credit limit on the sum of those accounts. Ratios above 30% work against you. So if you have a total credit limit of $5,000, you will want to be in debt no more than $1,500 when you apply for a home loan.
  • Length of credit history (15%): It’s beneficial for a consumer to have a track record of being a responsible credit user. A longer payment history boosts your score. Those without a long-enough credit history to build a good score can consider alternate credit-scoring methods like the VantageScore. VantageScore can reportedly establish a credit score in as little as one month; whereas FICO requires about six months of credit history instead.
  • Credit mix (10%): Your credit score ticks up if you have a rich combination of different types of credit card accounts, such as credit cards, retail store credit cards, installment loans, and a previous or current home loan.
  • New credit accounts (10%): Research shows that opening several new credit card accounts within a short period of time represents greater risk to the lender, according to myFICO, so avoid applying for new credit cards if you’re about to buy a home. Also, each time you open a new credit line, the average length of your credit history decreases (further hurting your credit score).

How to check your credit score

So now that you know exactly what’s considered a good credit rating, how can you find out your own credit score? You can get a free credit score online at CreditKarma.com. You can also check with your credit card company, since some (like Discover and Capital One) offer a free credit score as well as credit reports so you can conduct your own credit check.

Another way to check what’s on your credit report—including credit problems that are dragging down your credit score—is to get your free copy at AnnualCreditReport.com. Each credit-reporting agency (Experian, Equifax, and TransUnion) may also provide credit reports and scores, but these may often entail a fee. Plus, you should know that a credit report or score from any one of these bureaus may be detailed, but may not be considered as complete as those by FICO, since FICO compiles data from all three credit bureaus in one comprehensive credit report.

Even if you’re fairly sure you’ve never made a late payment, 1 in 4 Americans finds errors on their credit file, according to a 2013 Federal Trade Commission survey. Errors are common because creditors make mistakes reporting customer slip-ups. For example, although you may have never missed a payment, someone with the same name as you did—and your bank recorded the error on your account by accident.

If you discover errors, you can remove them from your credit report by contacting Equifax, Experian, or TransUnion with proof that the information was incorrect. From there, they will remove these flaws from your report, which will later be reflected in your score by FICO. Or, even if your credit report does not contain errors, if it’s not as great as you’d hoped, you can raise your credit score. Just keep in mind, regardless of whatever credit-scoring model you use, you can’t improve a credit score overnight, which is why you should check your credit score annually—long before you get the itch to score a home.

The post What Is a Good Credit Score to Buy a House? appeared first on Real Estate News & Insights | realtor.com®.