Renting vs. Homebuying: How Each Affects Your Credit
If you’re deciding whether to rent or buy a home, you probably have a lot of questions. Can you afford it? Is now the best time? Are you ready to live in one place for a while? You may even wonder how renting versus buying may affect your credit score.
To understand the answer, it helps to know how your FICO Score, the most widely used credit score, is calculated. FICO scores are based on five criteria: payment history, amounts owed, length of credit history, new credit and credit mix. Here’s how renting or buying a home can affect yours.
4 ways renting a home affects your credit
If you think only homeowners can achieve high credit scores, relax. You can build an excellent credit score without ever owning real estate. Here’s how renting can affect your credit.
1. Rent payments can help your credit history
Until recently, the most common credit scoring models didn’t include rent in your credit history. However, that’s changing.
Some landlords report rent payments to the credit bureaus. If you have a defined lease term, the payments appear like auto loans or other installment loans. If you pay month to month, your rent payments are reported similar to a credit card account.
“If you have a thin credit file, you can often add your rent payments to your credit report through a third-party system,” said Erica Sandberg, author of “Expecting Money: The Essential Financial Plan for New and Growing Families.” “You can enroll in what’s called a rent reporting service and have your rent reported on your credit report.”
According to Experian, one of the three major credit bureaus, various rental payment service providers report to them. Ask your property management company if it reports to Experian RentBureau.
Some landlords share payment information with rent-reporting companies that don’t report to all of the credit bureaus. However, future potential landlords will see your payment history if they check the reports.
2. Applying for a rental can temporarily cause your credit score to dip
When you give someone permission to request your credit report, you initiate a hard credit inquiry. This may temporarily reduce your credit score.
One hard inquiry won’t matter much. However, several hard inquiries can hurt your score. Limit credit checks to serious inquiries and avoid applying for other credit around the same time. One solution is to print your own credit report.
“If you’re going to do a lot of apartment hunting, bring your own credit report so they don’t all pull it,” Sandberg said.
3. Negative rent payment histories can hurt your credit score
You can pay your rent on time for years and never see it influence your credit score. Start missing those payments, however, and you could find yourself in trouble.
Landlords can report delinquent rent payments to any of the three credit bureaus. If your past due amount is sent to a collection agency, they will report it to the credit bureaus. Any judgments related to past-due rent or evictions appear in the public records section of your report. (There are options to repair your credit if needed.)
4. If renting is right for your finances, it’s probably right for your long-term credit
Not everyone should buy a home. If you might move in a few years, buying a home could be risky and expensive. Buying a home you can’t afford can be financially catastrophic.
You should know how renting versus buying will affect your credit score. But in the long run, the best move for your financial situation is probably the best move for your credit, too.
4 ways buying a home affects your credit
Responsible homeownership can boost your credit. But like any other financial decision, buying a home can also harm your credit if things go wrong. Here’s what you should know.
1. A positive payment history can help your credit
As you make mortgage payments on time, they become part of your credit history. A perfect record of payments over time is a great foundation for your credit history.
Try to always pay early or on time. But a payment a few days late typically won’t be reported to the credit bureaus.
“If you miss an entire billing cycle, that will hurt your credit report,” Sandberg said.
2. Your FICO debt ratios don’t change, but your debt-to-income ratio does
Thirty percent of your credit score is based on your ratio of debt to available credit. Purchasing a home dramatically increases your debt. How will that affect your score?
Fortunately, credit scoring models use revolving debt and installment loans, including home equity lines of credit. They don’t use your mortgage for your FICO debt ratio calculation.
Mortgage debt still affects you when you apply for a loan. Potential lenders look at your ability to pay, as shown by your debt-to-income ratio. They may turn you down if you have large mortgage payments in proportion to your income.
3. New loan applications can temporarily ding your credit score
Applying for a home loan creates a hard credit inquiry, which affects the new credit section of your credit score. One hard inquiry shouldn’t lower your score more than a few points, and the effect is typically temporary. However, multiple loan applications could lower your score — just when you need it to be at its best.
“Unfortunately, with home mortgages, you can’t bring your own credit report to a lender,” Sandberg said. “They’re going to pull it themselves.”
To avoid this problem, try to do all your mortgage rate shopping within a short period of time. According to FICO, multiple inquiries by auto or mortgage lenders within a close time span are generally treated as only one credit inquiry, thus having little impact on your score.
4. Sound long-term financial investments improve financial health — and credit
Purchasing a home can be one of the best financial decisions you make. It’s a hedge against inflation, as property values tend to rise over time. It’s a forced savings plan, as you make mortgage payments in good times and bad. And any decision that helps your long-term financial picture can improve your long-term credit as well.
That said, your credit score probably shouldn’t be your top priority after you purchase a home.
“What are you trying to do?” Sandberg said. “Have a perfect credit score? Your credit score will recover. Get what you want, make your payments on time and you’ll be fine.”
Just be sure you can afford any house you decide to buy.