Buying a place to call home is a life goal for many. It’s also one of the most expensive decisions you’ll make in your life. Imagine this situation: You’ve found an awesome home, only to realize the rate on your mortgage is too high. Why? Your credit score isn’t in tip-top shape.
Don’t know much about credit scores? Not to worry. We’ll cover what a credit score is and what makes up a credit score, how your score relates to mortgages, and how to improve it – so you’ll be ready when the opportunity arises.
What’s a credit score?
In Canada, your credit score is a number between 300 – 900, depending on the scoring model. When you get your free credit score from Borrowell, you’ll get the Equifax Risk Score ERS 2.0 – a popular and legitimate score used by many banks and lenders.
The better your score, the more likely you’ll be approved for a loan or various credit products, such as a mortgage, in the future. But how is a credit score determined anyway?
Your credit score starts to build as soon as you start using products that relate to credit. Common things that help build your score are your cellphone and credit card bills.
What makes up a credit score?
Now you know what a credit score is, but you also need to know what makes up a credit score. Having this knowledge may help you improve your score (which will come in handy when you go to apply for that mortgage). Here is a complete rundown of exactly what makes up your credit score.
- Payment history (35%) – Your payment history is how good you are at paying your bills on time. This is the most important factor that goes into your credit score.
- Credit utilization (30%) – Your credit utilization is how much available credit you’re using. To figure out your credit utilization ratio, add all the balances of your accounts. Then add the credit limits. Divide the total balance by the total credit limit and multiply by 100. Voila – you have your credit utilization ratio.
- Age of credit history (15%) – The age of your oldest account matters because lenders like to see that you’re responsible. It’s beneficial to have a long history of paying your bills on time.
- Credit inquiries (10%) – A credit inquiry is when a bank or lender makes an inquiry about your credit to determine your creditworthiness. This is called a hard inquiry which can have a slight negative effect on your score. A soft inquiry, on the other hand, is when you check your score yourself using a tool like Borrowell. Soft inquiries don’t affect your credit score.
- A total number of accounts (10%) – Having too few or too many accounts open can affect your credit score. If you have a lot of accounts, it might be beneficial to consider closing ones you don’t use anymore.
- Public records/derogatory marks – Bankruptcies and derogatory marks can have a serious impact on your credit score. Do your best to avoid them.
What does any of this have to do with getting a mortgage?
Your credit score is one of the factors that mortgage providers use to decide your mortgage rate – or how much interest you’ll be paying on your mortgage.
Generally speaking, your credit score should be around 650 (a good credit score) for traditional lenders to approve you for a mortgage. If you have a credit score of around 750+, then you’re in excellent credit score territory. If your credit score is above 650, the credit bureaus are basically telling mortgage lenders there’s a low chance you’ll default on your payments since you have a good credit history of paying your bills on time.
But if you’re credit score falls below 650, it’s still possible to qualify for a mortgage. However, you’ll likely only be approved by alternative mortgage lenders with higher interest rates.
How do I improve my credit score?
If mortgage rates scare you, you’re probably looking for a few ways to improve your credit score. The good news is that you can improve your credit score – you just need to follow a few steps.
1. Pay your bills on time and in full
Paying your bills on time is one of the biggest factors credit bureaus consider when determining your credit score. As long as you’re making payments, you’ll be in good shape.
It’s not advised to only make the minimum credit card payment but technically speaking, it’s all you need to make to ensure your credit score isn’t affected. Note that missing two payments in a row could dramatically lower your credit score.
2. Keep your credit utilization ratio down
Your credit utilization is the amount of credit you’re using compared to the amount you have available. This is known as your credit utilization ratio. Having a low ratio could improve your credit score because you’re not using all the credit that’s available to you.
3. Consider getting a secured credit card
It can be hard to build credit if you’re having trouble accessing it. If you’re too new to credit and you don’t qualify for a traditional credit card, you can consider applying for a secured credit card to build your credit score. With secured cards, you need to deposit funds onto your card before you can use it. It acts a little like a prepaid card, but your payments are reported to the credit bureaus, so your score will increase with time.
The bottom line
Now’s the time (not when you’re about to buy your first house or condo) to start working to improve your credit score.