Credit is basically your bread and butter when applying for all future loans, whether it is a mortgage, personal loan, or credit card. Not only can credit make or break whether or not you are approved for a loan, but it can also substantially affect the amount that you are approved for.
It is important to maintain a good credit score when applying for a mortgage. A good credit score can get you a mortgage with a great interest rate, no strings attached.
Whenever you apply for and use a product or service that you intend to pay back at a later date it is defined as credit. This can include loans, credit cards, and even telephone and cable bills.
Demonstrating a lack of responsibility towards your credit can ultimately be very expensive as you may be fraught with higher interest rates indefinitely, or you may not be approved for a mortgage at all.
“Your historical behaviour is one of the best measures of your future behaviour,” says Tom Reid, director of consumer solutions at TransUnion. “If you are shown to have handled credit as agreed, that’s going to set you up to get additional credit when you want it and at rates and terms that reflect the amount of risk, or lack thereof that you represent to a lender.”
Your credit report vs. your credit score
Your credit is assembled into a report and is managed by a credit-reporting agency such as Equifax of TransUnion. The report is updated on a daily basis and changes quite frequently. It will include information about your credit cards, loans, outstanding balances, and payment history up to the last six years.
Your credit score is an assessment of your financial health at a specific time. It is used to determine the maximum amount of your loan, and may also be used to set your interest rate. Lenders use a mathematical process to establish your credit score. It changes as your credit score changes, and is based on information in your credit report including payment history, any collection or bankruptcy against you, outstanding debts, account history, type of credit that you use (credit cards, loans, etc.), and the number of inquiries made about your credit report.
Typically, credit-reporting agencies use a Beacon or FICO score rating of 300 to 900, but specific lenders may use a slightly different scale. The higher you score on the charts, the lower the risk for a lender.
Improve your credit score
What credit score is needed for a mortgage? Before applying for a mortgage, many lenders suggest improving your credit score for at least six months to one year in advance. This is generally how long it takes to improve your credit score.
What is a good credit score in Canada?
“The general score that you’re aiming for is 700,” says Michael Lofquist, marketing and communications manager at Equifax.
However, the average Canadian credit score is about 650 according to First Foundation Residential Mortgages.
The most important factor that impacts your credit score is whether or not you pay your bills on time. This alone calculates approximately one third of your credit score, and even one missed payment will negatively affect you. Therefore, creditors suggest making at least the minimum payment amount by the due date.
“The best way to improve credit score is to seek only as much credit as you need, use it regularly enough to show a pattern of responsible use, pay everything on time and never go over limits,” says John Kane, manager of external communications at the Financial Consumer Agency of Canada.
The amount of credit that you utilize also affects your credit rating. “Try and stay below 35% utilization on revolving credit products such as credit cards,” says Reid. “Anything higher than this will have a negative impact on your score.”
Financial experts suggest maintaining a higher credit limit than what you will use. For example, if you need to borrow $3,500, then try to have a credit limit of $10,000, but be sure not to use more than that 35%.
Another factor to consider is the number of inquiries on your report. Each time you apply for a loan or credit card, the lender has the right to check your credit rating. Too many inquiries over a short period of time indicate somebody who is seeking credit and having a difficult time getting access to it.
However, this issue isn’t nearly as black and white and instead depends on the type of inquiries. Mortgage inquiries don’t have the same sort of impact because creditors believe that it makes sense to shop around for the best mortgage rate.
Each individual is permitted to request a free copy of his or her credit report on a yearly basis. Approximately 65% of all Canadian credit reports have some type of misleading, inaccurate or negative information, according to Beyer Mortgage Services Inc.
It is important to monitor your credit since this will provide you with a better understanding of what state you’re in, and you can be sure that there are no errors, says Kane. If you notice any inaccurate information on your report, then it should be reported to the lender in question, and a credit-reporting agency immediately.
Bad credit score
If, after checking your credit rating, you realize that you are a high risk to a lender and may not be approved for a mortgage. Don’t fret because there are some manageable solutions. The most viable option that lenders use is asking for a co-signer. This assures them that if you’re not able to make a payment, there will be someone who will. Also, if you are brand new to the credit scene and don’t have a lengthy credit history, then a co-signer will also come in handy.
All co-signers need to be aware of the responsibilities before signing. You aren’t just helping your friend or family member get that mortgage, but are making a commitment to pay the loan if the person that you are signing for is unable to do so, even if they file for bankruptcy. If your friend or family member is unable to pay the loan, then it may also negatively affect your credit report.
Getting approved for a mortgage through a bank may be slightly more difficult than going through a broker if you’ve got poor credit history. This is because brokers tend to have more access to lenders whose approval process may be more lenient. Though these lenders may approve you for a mortgage, they warn that you will most likely pay a higher interest rate.
It still may be worth looking into this option if you want to purchase a home now. For example, you might end up paying 10 to 15% more in interest for your mortgage. But depending on the amount of your loans, it still might make more sense than consolidating your credit card loans and then applying for a mortgage. The latter could cost you about 5% more in interest.
However, if you really want to get that mortgage at the best rate possible, then lenders suggest holding off and improving your credit rating before you apply.
“There’s no magic spell for any of this,” says Lofquist. “A lot of it really is just common sense. In terms of being a good credit risk, pay your bills on time, and don’t run up debt that you can’t afford to manage.”
By understanding how important credit history is and following these simple rules, you are on your way to getting approved for a mortgage at a great rate, and making your dream home a reality.
How to maintain a good credit history:
- Pay your bills on time
- Try to pay your bills in full by the due date. If you aren't able to do this, pay at least the required minimum amount shown on your monthly credit card statement.
- Contact your creditors if you are having trouble making payments.
- Make sure that your monthly account statement is correct.
- Read the statements and other material you receive from your credit card company carefully. Keep up to date on any fee increases or changes in your card's terms and conditions.
- Deal with companies you know and trust.
- Get a copy of your credit report from all three credit-reporting agencies at least once a year and make sure they are accurate.
- Don't accept or use any form of credit until you understand and are comfortable with its terms and conditions to avoid any misunderstandings between you and the credit issuer.
- Don't wait to report any unauthorized transactions on your account. Contact your credit issuer immediately if your bill includes items you did not buy.
- Don't go over the credit limit on your credit card.
Source: Financial Consumer Agency of Canada - http://www.fcac-acfc.gc.ca/eng/default.asp
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