How Mortgage Debt Impacts Your Credit

How Mortgage Debt Impacts Your Credit

You may not exactly 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, home ownership can be an excellent path to building wealth — per data from the Federal Reserve, homeowners have a median net worth that’s 40 times that of those who rent. Home values that have typically kept pace with inflation have no doubt lent a helping hand there (from May of 2019 to May of 2024, home prices have risen by a whopping 54%). 

Still, taking on mortgage debt is not something to be done cavalierly. That’s a lesson hard learned during the housing bubble and burst earlier this century. Those fortunes have turned. As of 2024, approximately 65% of Americans own their own homes, according to data from the U.S. Census Bureau, with the average American owing $244,498, per Experian’s 2023 State of Credit Report. Because home prices have risen so much of late, nearly half of properties are now considered “equity-rich” according to real estate data firm ATTOM. That means their combined loan balances are no more than half their estimated market values. 

But those are averages. As you look at taking on mortgage debt for the first (or umpteenth) time in your life, it makes sense to look at how it will impact your credit — and financial futures — for years to come.

A Matter Of Perspective

Ideally, throughout your borrowing lifecycle, you’ll want to keep your debt-to-income ratio at 35% or less. 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 payment, 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. That’s because the higher your debt-to-income ratio, you’re more likely to be viewed as being at a greater risk for defaulting on a loan. You can calculate your debt-to-income ratio here.

More House Than You Can Afford

So, what’s the moral of this story? 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, considering your ongoing expenses, credit card debt, student loans, car loans, and the stability of your income.  Certified Financial Planner Amy Richardson. “Before making a home purchase, make sure your financial house is in order.” In other words, the calculation is never just about the house itself.

Tasha Bishop, director of digital innovation at Apprisen, a financial services nonprofit sponsored in part by the United Way, estimates that about 35 percent of mortgages that are approved are actually 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 take a look not just at the cost of the mortgage, insurance and taxes but 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 and the like?  Not to mention the maintenance that will likely run 1 to 2 percent of the value of the home 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 at the same time 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. 

Also, 10% of your credit score is informed by something called “credit mix.” This means exactly what it sounds like — a mix of the different types of loans you own. 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, the more comfortable lenders become in lending to you.”

Finally, there’s the length of your credit history — how long you’ve been making 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 a ton of questions and subject her to a bunch of 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.