Buying a house is a known strategy for building wealth over time. But it could also help your finances in the short term. Homeownership could raise your credit score in three key ways.
1. Your payment history will be reported to the credit bureaus
Renting an apartment is more expensive than ever. Ninety major cities in the United States have median rents that exceed 30% of median household income, according to a 2014 report in The New York Times. This means that rent is unaffordable by conventional standards in many parts of the country.
To make matters worse, rent may not be reported in a way that will give your credit a boost.
But because mortgages are credit products, payments are reported to the credit bureaus. When you make payments by their due dates, you’re adding positive information to your credit reports. Over time, this will have a powerful, positive effect on your credit, because payment history weighs heavily in credit scoring.
The takeaway? Making mortgage payments on time and in full every month is crucial if a home loan is going to improve your credit. If you can follow these best practices, your score will benefit from owning over renting.
2. You’ll improve your account diversity
Interacting with credit is essential for building a good credit score, and diversifying the types of accounts on your credit reports will give you a further boost. A modest portion of your score is determined by mix of accounts, so if you don’t have an installment loan in your credit history, buying a home with a mortgage could help.
“The FICO score algorithm looks at a person’s mix of credit cards, retail accounts, mortgages, car loans and other types of credit accounts. A broad credit mix may be beneficial to a person’s FICO score,” Jeff Scott, a FICO spokesman, says in an email interview.
But it’s important to keep your expectations reasonable. Since mix of accounts makes up only a small portion of your score, adding a mortgage to your credit report is unlikely to have a dramatic effect on it. Plus, “The actual score impact of each person’s credit mix varies based on the other information in their credit reports,” Scott says.
3. In a pinch, a home equity loan could get you out of a jam
Credit card debt is notoriously expensive, but many people don’t realize that it can have a negative effect on their credit, too. Another large influence on your credit score is determined by amounts owed, and credit utilization ratio has a big influence on this category.
Your credit utilization ratio is the amount of credit you have in use, compared with your overall credit line. As credit utilization ratio goes up, credit scores tend to go down. Consequently, carrying a balance on your cards is damaging to your score.
One way to fix this quickly is by refinancing your credit card debt. Homeowners may have the option to do this with a home equity loan, which means converting revolving credit card debt into installment debt. Only revolving credit card accounts are factored into your credit utilization ratio. So this simple move will drive down your credit utilization ratio, giving your credit score a fast and perhaps significant lift.
Another benefit to using a home equity loan to pay off credit card debt is that you’ll end up saving money on interest. Home equity loans typically charge much lower rates than plastic or personal loans, which are another popular refinancing option for people with credit card debt. Plus, the interest you pay on a home equity loan may be tax-deductible.
However, it’s important to use a home equity loan responsibly. Since it’s secured by your property, defaulting could cause you to go into foreclosure. Again, make it a priority to pay on time and in full. This is the best way to ensure that you’ll hold on to your good credit standing — and your home.
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