Everything You Wanted To Know About Credit
Unless you’re related to the Kardashians and can afford to purchase everything (including a home) in cash, building and maintaining a good credit score is key.
A good credit score not only lets you qualify for a mortgage, it can help you get the best mortgage rate, potentially saving you thousands in interest over the lifetime of your mortgage. If your credit score is on the low side, you could face higher mortgage rates or your application could be turned down.
Credit History, Credit Report and Credit Score
There are three main components of your credit: credit history, credit report and credit score. Your credit history is similar to your resumé. It summarizes whenever you’ve borrowed any money. This includes the student loan on which you’re only paying the minimum or that credit card you never paid off in college. Your credit history is a recap of anytime you’ve borrowed money. Your credit report is similar to a yearly review of your credit history.
Lastly is your credit score. Your credit score is the all-important number that carries a lot of weight with lenders. This number helps lenders make up their mind about whether to approve your mortgage. The better your credit score, the more likely your mortgage terms will be more favourable. Credit scores typically range from 300 to 900.
Credit reporting agencies calculate and update your credit history and credit score.
You can request a free copy of your credit report only once a year.
The simplest way is to use Equifax and TransUnion’s interactive phone services. You can also download and complete forms from the websites of Equifax and TransUnion. (In case you’re wondering, it won’t lower your credit score to check it yourself.)
It’s a good idea to request your credit report and credit score a minimum of a year before you’re thinking of buying a home, otherwise you could be in for a rude awakening. (If your credit score is low, you’ll need time to improve it before applying for a mortgage. This may take a year or more because of reporting lags.) If you find any inaccuracies or mistakes on your credit report, take the necessary steps to get them fixed right away.
Understanding Your Credit Score
Five main factors affect your credit score. It’s important to understand each of them to help maximize it.
1. Payment History
Your payment history has the biggest impact on your credit score. As the saying goes, “The best predictor of future behaviour is past behaviour.” Things that can hurt your payment history include missing or making late payments, any debts that have been written off or sent to collections, and filing for bankruptcy. To protect your credit score, pay your bills on time. If you can’t pay the full amount, pay at least the minimum payment to keep your credit in good standing.
2. Available Credit
After payment history, available credit (also called credit utilization) carries the second most weight with lenders. Your total available credit (not your total credit limit) counts toward your credit score. Your available credit is how much credit you have at your disposal. It’s your credit limit (how much credit you have available to borrow) minus your current balance.
To determine your total available credit, tally up the credit limits on all your credit products (credit cards, lines of credit and so on). Ideally, you’ll want a credit utilization of less than 35%, but never, ever go over 70%, even if you pay off your balance every month. When you’re using a higher percentage of your available credit, lenders tend to get nervous and see you as a greater risk, even if you still pay your balance in full and on time. Have more credit than you need and use it responsibly.
For example, if you have a Visa credit card with a limit of $6,000 and a line of credit for $10,000, your total available credit is $16,000. Try not to borrow more than $5,600 at any time (35% of $16,000).
3. Number of Credit Inquiries
When it comes to credit inquiries, there are two types: soft hits and hard hits. Soft hits, such as asking for a copy of your credit report, won’t impact your credit score. Hard hits are inquiries that count toward your credit score.
Whenever you apply for credit, whether it’s a credit card or mortgage, lenders ask for a copy of your credit report. When this happens, a credit inquiry is recorded—a hard hit. Inquiries are expected every now and then, but too many over a short period can negatively impact your credit score.
Lenders can see how many credit inquiries have been made. To protect your credit score, limit the number of hard hits. When shopping for a mortgage, apply only at lenders you’re serious about. And try to apply for mortgages within a two-week period (these inquiries usually will be lumped together and treated as one).
4. Credit History Length
You may have heard that no credit can be as bad as poor credit. Lenders want to see that you have a track record of making your payments in full and on time. The longer your credit account is open, the more it helps your credit score.
Some people lack a credit history (maybe they’ve been afraid to sign up for a credit card after the financial crisis, or they’re a recent grad or new immigrant). If that’s you, take steps to start building your credit history today. Apply for a no-fee credit card and pay it off in full each month. Ideally, have at least two unsecured forms of credit with clean payment histories (paying off your balance in full on time each month) of a minimum of 24 months, with a limit of at least $2,000 each.
5. Types of Credit
Having only a single credit type, like a credit card, can hurt your credit score. Spice up your credit report with different types of credit. Instead of carrying a wallet full of credit cards, replace some of that plastic with a line of credit or personal loan. A word of caution: although it’s good to have different credit types, don’t go overboard—apply only for credit you truly need.
This post was written by Sean Cooper, bestselling author of the book, Burn Your Mortgage. Sean is also a mortgage broker at mortgagepal.ca.