Does a Mortgage Preapproval Affect Credit Score?

Buying a home is one of the biggest financial decisions most people will ever make. As you embark on this journey, understanding the various steps involved, including getting preapproved for a mortgage, is crucial. A common concern for prospective homebuyers is whether seeking mortgage preapproval will negatively impact their credit score. This comprehensive guide will explore the relationship between mortgage preapproval and credit scores, helping you navigate the process with confidence.

Understanding Credit Scores and Their Importance

Before delving into the specifics of mortgage preapproval, it's essential to understand the basics of credit scores. Your credit score is a three-digit number that represents your creditworthiness – essentially, how likely you are to repay borrowed money. Lenders use this score, along with other factors, to determine whether to approve your loan application and at what interest rate.

Key Components of a Credit Score

Credit scores are typically calculated based on several factors, each carrying different weights:

• Payment History (35%): This is the most significant factor. Making on-time payments demonstrates responsible credit management.
• Amounts Owed (30%): This refers to the total amount of debt you owe relative to your credit limits. Keeping your credit utilization (the amount of credit you're using compared to your total available credit) low is crucial.
• Length of Credit History (15%): A longer credit history generally indicates a more established track record of managing credit.
• Credit Mix (10%): Having a variety of credit accounts (e.g., credit cards, installment loans) can positively impact your score, but it's not essential.
• New Credit (10%): Opening multiple new credit accounts in a short period can negatively impact your score.

Mortgage Preapproval: What It Is and Why It Matters

Mortgage preapproval is a preliminary assessment by a lender of how much you may be able to borrow to purchase a home. It involves providing the lender with your financial information, including income, assets, and debts. The lender then reviews this information and provides a preapproval letter, stating the maximum loan amount you're likely to be approved for.

Benefits of Getting Preapproved

• Determining Affordability: Preapproval helps you understand how much you can realistically afford, preventing you from overextending yourself financially.
• Strengthening Your Offer: Sellers often prefer offers from preapproved buyers because it demonstrates your seriousness and financial readiness.
• Streamlining the Loan Process: Preapproval allows you to gather necessary documents and address potential issues upfront, potentially speeding up the final loan approval process.
• Negotiating Power: Knowing your borrowing power gives you leverage during negotiations with sellers.

The Impact of Credit Inquiries on Your Credit Score

Credit inquiries occur when a lender checks your credit report. There are two main types of credit inquiries: hard inquiries and soft inquiries.

Hard Inquiries vs. Soft Inquiries

• Hard Inquiries (also known as hard pulls): These occur when you apply for credit, such as a mortgage, credit card, or loan. Hard inquiries can slightly lower your credit score, especially if you have many within a short period. Each hard inquiry signals to lenders that you are actively seeking credit, which can be seen as a potential risk.
• Soft Inquiries (also known as soft pulls): These occur when you check your own credit report, when lenders pre-approve you for offers, or when companies perform background checks. Soft inquiries do not affect your credit score.

How Mortgage Preapproval Affects Your Credit Score: The Hard Inquiry Factor

When you apply for mortgage preapproval, the lender will typically perform a hard inquiry on your credit report. This is because they need to assess your creditworthiness to determine the likelihood of you repaying the loan. As mentioned earlier, hard inquiries can have a small, temporary impact on your credit score.

The Impact is Usually Minimal and Temporary

While hard inquiries can lower your score, the impact is usually minimal, often a few points. Furthermore, the impact is temporary, and your score will typically recover within a few months, especially if you continue to manage your credit responsibly. The duration of the impact can vary depending on your credit history and the frequency of other hard inquiries.

The "Rate-Shopping" Exception: Minimizing the Impact of Multiple Inquiries

Fortunately, credit scoring models recognize that consumers often shop around for the best mortgage rates. To account for this, they typically treat multiple hard inquiries within a specific timeframe (usually 14 to 45 days, depending on the scoring model) as a single inquiry. This is often referred to as "rate-shopping."

How Rate-Shopping Works

When you apply for a mortgage, it's advisable to compare offers from multiple lenders to secure the best interest rate and terms. The rate-shopping exception allows you to do this without significantly impacting your credit score. As long as you apply for multiple mortgages within the designated timeframe (e.g., 30 days), the credit bureaus will likely treat these inquiries as a single inquiry, minimizing the overall impact.

Tips for Rate-Shopping Effectively

• Shop Around Within a Short Timeframe: Focus your mortgage preapproval applications within a 14-45 day window to take advantage of the rate-shopping exception.
• Focus on Reputable Lenders: Research and choose reputable lenders who offer competitive rates and terms.
• Compare Loan Estimates Carefully: Don't just focus on the interest rate; carefully compare loan estimates from different lenders, including fees and other costs.
• Consider Working with a Mortgage Broker: A mortgage broker can help you compare offers from multiple lenders and guide you through the process.

Factors That Can Exacerbate the Impact of Hard Inquiries

While the impact of a single hard inquiry is usually minimal, certain factors can exacerbate its effect on your credit score:

• Already Having a Low Credit Score: If your credit score is already low, even a small decrease from a hard inquiry can have a more noticeable impact.
• Applying for Multiple Types of Credit Simultaneously: Applying for a mortgage, credit card, and auto loan all at the same time can lead to a significant number of hard inquiries, potentially lowering your score more substantially.
• Having a Short Credit History: If you have a limited credit history, a hard inquiry can have a relatively larger impact because there's less other information for the credit bureaus to rely on.
• Recent Hard Inquiries: If you've already had several hard inquiries in the recent past, another inquiry can further lower your score.

Maintaining a Healthy Credit Profile During the Home Buying Process

Besides understanding the impact of mortgage preapproval on your credit score, it's important to maintain a healthy credit profile throughout the home buying process. Here are some tips:

• Continue Making On-Time Payments: Ensure you continue making all your payments on time, as payment history is the most crucial factor in determining your credit score.
• Avoid Opening New Credit Accounts: Refrain from opening new credit accounts, as this can trigger hard inquiries and potentially lower your score.
• Keep Credit Utilization Low: Keep your credit card balances low relative to your credit limits. Aim for a credit utilization ratio of 30% or less.
• Monitor Your Credit Report Regularly: Check your credit report regularly for errors and discrepancies. You can obtain a free credit report from each of the three major credit bureaus (Equifax, Experian, and TransUnion) annually through AnnualCreditReport.com.
• Address Any Negative Items Promptly: If you identify any negative items on your credit report, such as late payments or collections, address them promptly.

The Bottom Line: Don't Let Fear of a Credit Score Dip Deter You

While mortgage preapproval does involve a hard inquiry that can slightly lower your credit score, the impact is usually minimal and temporary. Furthermore, the benefits of getting preapproved, such as determining affordability and strengthening your offer, far outweigh the potential negative impact on your score. By understanding the rate-shopping exception and maintaining a healthy credit profile, you can minimize the impact of hard inquiries and navigate the home buying process with confidence.