A Primer on Credit Scores And How It Affects Your Mortgage
A Primer on Credit Scores And How It Affects Your Mortgage
What is a credit score and what does it measure?
A credit score is a number that is given to you by the three major credit bureaus - Equifax, TransUnion and Experian. It is critical in the mortgage approval process. This number is calculated according to your financial history of paying debts. It measures things like how on time you are with payments, whether or not you have any bankruptcies or lawsuits, how much debt do you carry versus what people of your income level typically carry, am I requesting loans more than 10 times in the last 2-5 years - am I applying for more than two new accounts of any kind in one year?
How do I get my credit score?
Luckily for Canadians, there are a variety of ways to find out if you have bad credit or can look forward to reasonable mortgage loans. While the process may seem intimidating at first, it's important to know how Canada's mortgage underwriting system works – and your individual score affects it greatly.
Canada's credit scores range from a minimum credit score of 300 to a maximum of 900, and the higher your number is, the better. Obtaining a score near 800 will make you look like an "A" student. You can get free copies of your credit history from both the federal government agency called the Privacy Commissioner of Canada, as well as from Equifax and TransUnion.
Many financial institutions publish their own credit scoring models, which are often different from the widely used Fair Isaac Corporation (FICO) model. While all scores attempt to assess your level of risk as a borrower, there are some differences between them. For example, some private lenders may prefer one type of score or another. Or they may offer more favourable terms to those with a higher credit score.
How can I improve my credit score?
Review your credit report. The first thing to do is review your credit report thoroughly for any errors or omissions so you can correct them immediately.
One step on the way to getting a good credit score is by lowering the amount of debt in relation to your available credit limits can help improve your credit score. On that path, a good idea is to increase your available credit limits by asking for an increase from lenders or card issuers such as banks and other financial institutions that offer secured loans.
Another option is by opening new lines of credit with suppliers such as department stores. The balance across all these types of debt should be at least 20%. You should also keep your accounts open and in good standing.
To avoid poor credit, pay any bills or credit card balances on time, particularly those that have interest rates higher than others. For example, if you have a credit card with a relatively high rate of 10%, pay off your balance as soon as possible to reduce the amount of interest you'll pay over time.
If you've missed payments in the past, contact creditors and set up a repayment arrangement that you can stick to. Paying bills, or other things like car loans, student loans, and having a solid income and employment history can greatly improve your chances to get a mortgage.
What's on the credit report?
In some cases, a lender will ask you to sign a form authorizing them to check your credit history so they can decide whether or not to give you a loan.
For example, if you are applying for a car loan, lenders can access your file without your consent. For credit cards and mortgages, lenders need your permission to check your report to see if you meet even the minimum credit score requirements.
In many cases, a lender will ask you for both a credit score and a credit report from one or two of the major bureaus in order to make an assessment about whether you qualify for a loan.
Once you have reviewed your file, if you believe there are errors, you should contact the credit bureau in writing to dispute them to make sure you get back to an accurate, and hopefully good credit score.
How do lenders use my credit score?
Credit scores are based on statistical models that try to predict whether or not you'll repay your loan. Credit scores also consider how much debt you have relative to the amount of available credit you have at any given point. For example, if you have a total credit limit of $20,000 but owe $15,000 on your credit card, your ratio is 75 percent.
If you consistently pay off all or most of this debt every month, that's considered to be good. In the eyes of a mortgage lender, that means that you can manage debt payments. If you keep maxing out your cards and routinely go into the red, that's considered to be a bad practice, and you may not meet the minimum credit score required to get mortgage approval.
Many mortgage lenders use the FICO Score as their preferred score, but they can ask for other scores as well. Two of the most important factors lenders consider when assessing your credit score are:
Payment history: almost half of your credit score is determined by how you manage your payments and shows whether you pay your bills on time.
Credit utilization: this is the ratio of how much debt you have relative to your total credit limit, expressed as a percentage. If you owe $2,500 on a card with a limit of $10,000 for example, that means your credit utilization is 25 percent.
The higher this number is, the greater the risk you are considered to be.
Additional factors include the length of time your credit accounts have been open, the number of inquiries on your file, how many monthly payments you make on your credit accounts, whether there are any delinquent or charged-off accounts showing on your file, and whether you have ever declared bankruptcy.
This is a measure of your financial stability and whether or not you're able to show mortgage providers that it's safe it is to provide you with a mortgage loan that you can repay while keeping up with monthly housing costs, property taxes, and more. Better credit score = less risk for the mortgage lenders.
Some mortgage lenders prefer the VantageScore, produced by credit bureau Equifax. The score considers dozens of other factors in addition to payment history and utilization such as your total level of debt (credit card balance plus installment loans), any public records that show up on your file like court judgments or liens, and how long you have lived at your current address.
These additions to your mortgage application can help or hinder your chances so think carefully, and make use of your free credit report to make the best choice.
How does my credit score affect my mortgage?
If your credit score is below 680, it means that you're a high-risk borrower and will have to pay much higher interest rates when applying for a mortgage. If you're in this category, it's important to work on improving your credit score in order to avoid paying a lot more in mortgage payments over time.
Creating a solid credit history is also important for improving your credit score. Start by obtaining free credit score reports from credit reporting agencies like Equifax Canada (1-800-465-7166; http://www.equifax.ca/ ), TransUnion Canada (1-800-663-9980; http://www.transunion.ca/ ) and the Canadian Bankers Association (http://www.cba.ca ), and review them carefully for errors, including incorrect addresses and other information that could be detrimental to your ability to obtain credit in the future. If the reports contain errors, you can ask the credit bureau to fix them by following their guidelines.
No one wants a poor credit score to impede their future.
Is a high credit score crucial for a good deal on a mortgage?
No, it's considered to be just one factor in the mortgage approval process that mortgage lenders use in their decision-making when deciding if you will be approved for a mortgage, and what its terms will be. The higher your score though, the more doors will open for you so it's easier to find competitive rates even if less competition exists.
What is the link between your credit score and a mortgage?
If you are borrowing money for a mortgage, then typically major banks will request to see your credit score in order to determine how much they will be willing to lend you. This number is called the 'Bank's Decision'.
The bank looks at several factors in addition to your credit score in order to make their final decision. For example, they may look at your income and the amount of debt that you currently have. Typically, if you have a high credit score and low debt to income ratio (DTI), then you will receive a higher offer on your mortgage.
A good credit rating is helpful when it comes time for applying for a mortgage, whether it's your first or next one. Your credit rating can impact your interest rate in several ways. The most common way that your credit rating affects you is when it comes time to renew your mortgage or apply for a new one. Your current credit rating will affect the rate you're given and, depending on how good your credit is, can either help reduce your monthly payments by reducing your interest rate or increase the amount of money you need to borrow because of that higher interest rate.
A solid credit score can also be important during negotiations. In a competitive market, if you have a solid credit score and can provide proof that you've paid your bills on time, it could increase the chances of your offer being accepted over others because lenders will be more willing to work out a favourable mortgage with you.
Although there are many factors involved in getting a mortgage, establishing good credit is an important one. A strong credit rating can help you obtain a mortgage more quickly and with potentially lower interest rates, saving you money over the long run.
What does DTI mean?
The debt-to-income ratio is how much money someone makes versus how much they owe. For example, if someone makes $50k a year and they have $10k in debt from their credit cards, then their DTI would be 50%.
What does a high DTI mean?
Typically a high DTI means that you are going to pay more interest on your mortgage. That is because people who have a higher DTI typically have a higher risk of being unable to pay off their debts due to circumstances such as loss of employment.
What does a low DTI mean?
If you have a low DTI, then typically you will be able to borrow more money from the bank because they believe that you have a lower risk of defaulting on your payments. (Note, they are not saying that you will definitely pay back the money, but instead that they believe you have a lower risk of defaulting on your payments).
Sidenote: Interest rates are typically calculated according to the borrower's DTI ratio. People who have very low debt and income levels can oftentimes receive interest rates as low as 1.5%. While the credit score needed to achieve this is hard, it's not impossible if you stay on top of your financial health.
What happens to my credit score if I'm self-employed?
Self-employed individuals have a hard time successfully obtaining mortgage approval because their income cannot be verified in a conventional manner. It's necessary to prove the business has been in operation for at least six months, and there is proof of consistent revenues through tax returns.
In order to get an idea about your financial responsibility, lenders will sometimes need to see that you've successfully obtained credit before - such as with a car loan or line of credit. You'll need to provide sources of revenue (from pre-tax income) like salary statements, bank statements showing deposits matching dates on invoices or other third-party documentation. It may then be worth looking into an alternative lender.
What is an alternative mortgage lender?
As opposed to traditional lenders, an alternative lender is a company that deals with your credit history differently than banks do. You can find alternative lenders through referrals from people you know or searching the internet for companies that are willing to work with borrowers who have weak borrowing history.
These companies may be more lenient in their lending requirements, but they will typically charge a higher interest rate for this leniency. You can use services like CreditKarma to access your current credit score for free and have a look at alternative lending options available in Canada.
To sum up, here's the gist of what you need to know.
A good credit score is important when it comes to mortgages in Canada. A high credit score can help you get a mortgage with a lower interest rate, while a low credit score can help you borrow more money. Your credit score is one of several factors that banks look at when deciding whether or not to give you a mortgage.
A bad credit score will make the process of buying a house complicated and costly. The first thing you need to do is check your credit score, you might be surprised by a strong credit score and already meet the minimum credit score required for a reasonable loan. To get a mortgage, a good credit score opens a lot more doors but if you need help when applying for a mortgage, this is something that a real estate agent can help with. They often work in tandem with a mortgage broker to help you find the right score for a mortgage and inform you about other credit products that may be useful to you.
You can improve your credit score by taking small steps like cancelling unused lines of credit, paying off your debt, not applying for too much credit. You can also work on checking your bank statements to make sure there are no fraudulent transactions and check you're only making the minimum monthly payments on debts like car loans or student loans.
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