In Focus – SCCCU Blog

You may not love paying your mortgage every month, but chances are you appreciate the value of home ownership — particularly if, after spending time as a renter (and worrying about annual rent increases), you were eager to start building equity in an asset.

In fact, homeownership can be an excellent path to building wealth. The Federal Reserve reported that homeowners have a median net worth 40 times that of renters. Home values that have typically kept pace with inflation have no doubt lent a helping hand there (from May 2019 to May 2024, home prices have risen by a whopping 54%).

As you consider taking on mortgage debt for the first (or umpteenth) time in your life, it makes sense to consider how it will impact your credit (and financial future) for years to come.

A Matter of Perspective

Ideally, you’ll want to keep your debt-to-income ratio at 35% or less throughout your borrowing lifecycle. What does that look like in practice? For example, someone with a $200,000 annual salary before taxes with $5,000 in total debt to pay each month (including credit cards, car payments, mortgage, student loans, etc.) would have a 30% debt-to-income ratio, which is considered good.

On the other hand, someone earning the same amount with $9,000 in monthly debts would have a 54% debt-to-income ratio, which is considered risky. A person in this situation might be unable to manage an unexpected expense in the event of an emergency and could face limited borrowing options from lenders.

So, the lesson is that the higher your debt-to-income ratio, the more likely you are to be viewed as being at a greater risk of defaulting on a loan.

More House Than You Can Afford

You’ve likely heard it before: “Don’t buy more house than you can afford.” No one wants to be “house poor” and unable to enjoy a vacation or save for retirement for fear of being unable to cover the mortgage. That’s why you should step back and take a comprehensive look at your financial picture before you take on a mortgage.

Tasha Bishop, Director of Digital Innovation at Apprisen (a financial services non-profit sponsored in part by the United Way), estimates that about 35% of approved mortgages are unrealistic for consumers. Many people “really trust the lender’s numbers and think that if they’re approved, they must be able to afford it,” Bishop says. But this isn’t always the case — just because you can get approved for an expensive house doesn’t mean you should sign on the dotted line.

To figure out what you can handle, make sure you look not just at the cost of the mortgage, insurance, and taxes but also at the cost of moving into—and then living in—the house you choose. What are the monthly costs for utilities, homeowners association (if there is one), landscaping, snow removal, etc.? Not to mention the maintenance that will likely run 1%—2% of the home's value each year.

A Drop in Your Credit Score to Start

Finally, there’s the impact on your credit itself. Unless you prefer cruising in a Ferrari or a Lamborghini, your home will almost always be the most substantial debt on your personal ledger. In the context of your credit score, the size of it compared with the rest of your debts means it will meaningfully alter your debt-to-income ratio — the percentage of your gross income each month that you must spend to pay off your debt. For that reason alone, it’s not unusual for first-time home buyers to see their credit scores drop by 15-40 points out of the gate. Don’t worry. It’s temporary. Within a few months of on-time payments, you should see it start to come back.

How Mortgage Debt Can Help Your Credit

Overall, mortgage debt (as long as it’s well handled) will likely bolster your credit in a number of ways — some directly and some indirectly. For starters, with on-time monthly payments on your mortgage, you’ll demonstrate responsible financial behavior, and your credit report will reflect this. Also, as you pay your mortgage down, you’ll slowly but surely own more of your home while you owe your lender less — in other words, your debt-to-income ratio will come down. That, too, is a credit booster. At the same time, your home is growing in value (after a few years, you could probably sell it for more than what you paid), all of which helps lenders see you as an overall better credit risk.

Additionally, 10% of your credit score is informed by a “credit mix,” meaning you have a mix of different loan types. In general, lenders like to see a diverse mix of credit types (such as student loans, car loans, home loans, and even credit cards) because your ability to manage multiple obligations reflects positively on your ability to keep your financial house in order — thus making you a less risky borrower overall. “Lenders want to know that you can manage all different types of loans,” says Matt Schulz, Chief Credit Analyst at LendingTree. “The more you show you can handle your loans, the more comfortable lenders become in lending to you.”

Finally, there’s the length of your credit history or how long you've made payments. This is a factor comprising 15% of your credit score, so as the years go by, your record of making on-time payments to your mortgage lender can offer a substantial boost to your score. The longer your history of on-time payments, the more trustworthy you become in the eyes of lenders.

Schulz compares credit history to a teen borrowing the family car from her parents. The first time she asks mom or dad for the keys, they’ll likely ask many questions and subject her to many rules and restrictions. However, if she shows over time that she can handle the responsibility — coming home before curfew, filling up the gas tank, avoiding speeding tickets and accidents — her parents will grow more and more comfortable until they eventually think nothing of handing the keys over. It’s the same thing with lenders. The longer and more consistently you pay on time, the more comfortable they’ll be with lending to you.