Your Credit and Mortgage Qualification
Your credit score is probably the most important component of your mortgage application because it's the primary factor that banks and lenders use to determine your creditworthiness. It tells lenders how likely you are to pay your bills on time, because it reflects every credit card, loan payment and late payment you've ever made – and every bankruptcy or credit problem you've undergone. With so much weighing on this tiny little number, it's important to understand what it is, how it's calculated and what you can do to manage it.
Accredited Mortgage Professional
1. What is a Credit Score?
Canada's two credit bureaus, Equifax and TransUnion, are independent companies that make their money from collecting information about your credit history.
Other businesses that utilize the services of these bureaus – meaning, they report to and collect information from them – include virtually every credit card company, loan entity (student or otherwise), car leasing company, utility company, collection agencies and pretty much anyone else you pay money to on a regular basis – with the exception of your mortgage. For some reason, mortgages aren't reflected on your credit report.
The bureaus monitor the activity on a regular basis (typically monthly) and assign a 'credit score' to you. This number ranges from 300 to 900, although anything in the 700s is considered to be good. To qualify for credit, you typically don't want to be lower than 620, and definitely not lower than 600.
In general, the higher your score, the lower the probability that you will become delinquent on credit extended to you. And while many lenders use bureau scores to help them make lending decisions, each lender will base its decision on more than just the score.
2. What is used to calculate my Score?
While each credit bureau is different, both rely on similar algorithms to determine an individual score. Below is an approximate breakdown:
Payment History (35%): Your credit score will be higher if you pay your bills on time, as opposed to submit late payments – or worse – not pay outstanding debts at all. If you have a poor payment history – meaning, you've missed a payment, declared bankruptcy or had a debt that went into collections – this will negatively affect your credit score. The more time that passes since you've paid the outstanding debt or declared bankruptcy, however, the less heavily this delinquency will be weighed.
Current Debt (30%): Just because you've been approved for a $10,000 credit limit doesn't mean you should use it all! The more credit you use, the lower your score will drop. TransUnion recommends keeping your credit card balance below 50% of your allotted limit, and ideally around 30%. With this in mind, if you're someone who relies on a credit card a lot, it might be better to implement some spending discipline rather than asking your credit card company to drop that $10,000 limit to $500.
Length of Credit History (15%): The longer you've been proving yourself as a reliable borrower, the higher your score will be. Someone without a lengthy track record of paying back debts is likely to have a reduced credit score.
New Credit (10%): If you have a lot of companies viewing your credit report in a short period of time – whether they're landlords, credit card applications or mortgage brokers – a red flag will go off at the credit bureau, and consequently lower your score. Regardless of what the reasons are, the bureaus see that activity as a sign of desperation – meaning, you're in financial trouble and looking for a way out. Try to avoid applying for every credit card application that comes your way.
Types of Credit (10%): Your credit score is partly calculated based on the types of credit and loans you have – such as credit cards, retail accounts, installment loans, mortgages, and consumer finance accounts. A healthy mix of all of these types will boost your score.
3. What can I do to improve my Credit Score?
Keeping the above information in mind, below are the most important things you can do to improve your credit score:
Pay your bills on time. If possible, set up automatic payments for all of your regular bills. Many credit card companies also have a service that allows you to automatically pay your minimum balance every month.
Don't max out your credit cards. If you have a big purchase to make, consider applying for a lower–interest line of credit, or home equity line of credit (if you already own a home).
Choose your credit wisely. While it may be tempting to receive a new iPod – or 100,000 AirMiles – for applying for a new credit card, it's not worth the havoc unnecessary credit can wreak on your credit score. Try to limit all new credit applications to those you genuinely need.
Keep an eye on your credit profile. Make sure there are no erroneous charges – and no fraudsters taking over your identity. Both Equifax (www.equifax.ca) and TransUnion (www.TransUnion.ca) allow you to order your credit profile for free on an annual basis. It's wise to order one from each company, since they feature different information.
Be patient. Unfortunately, it can take a while to see the fruits of your credit–improving labours. If you follow the above steps on a consistent basis, however, you'll be qualifying for that stellar mortgage rate in no time!