Understanding Borrowing Practices to Work in Your Favour
With the yearly talk of responsible borrowing practices, consumers will want to take extra steps to ensure their credit history is working in their favour. This week let’s take a look at Canada’s credit scoring system and steps you can take to make sure you are on the right track.
When you are planning to purchase or to refinance a home, your personal credit history factors heavily on the lender’s decision to approve your mortgage and at what interest rate. While it is true that they also take into account the applicant’s strength of income and overall debt load, ability to manage the current debt speaks volumes to mortgage lenders and could influence the lender’s decision, so it is beneficial to understand the process before getting started.
In Canada there are two main companies, Equifax Canada and Trans Union, which collect credit information and generate a report, known as a credit bureau. Since mortgage lenders predominantly use Equifax, we will focus on their scoring criteria.
Equifax analyses each bureau and awards the individual an overall score, known as a beacon score or FICO score. In Canada the score can range from 300 up to 900, with the highest score being the goal.
The beacon score itself is derived from five distinct characteristics of you credit history, each playing an important part. Clearly understanding these components will show you how to make your credit score work in your favour and correct any old patterns that could be dragging your rating down.
Most Important: 35% of your beacon score is determined by your previous credit patterns. This is the largest consideration when generating your beacon score and therefore should be treated as sacred. It is extremely important to make at least your minimum payment on any loan or credit card by the required due date. The size of the minimum payment does not matter usually, only the fact that you are on time. There is no discretion here so don’t lose points on the one!
Second Most Important: How much debt do you currently have? Equifax allocates 30% of your score here. Carrying a balance of more than 75% of your total limit is a big no-no. Even more damaging to your score is exceeding your credit limit, so be wary of getting into that habit. If your credit balances are over the 75% marker and you are unable to pay them down quickly, consider requesting an increase in your credit limit. This will improve your beacon score and look better to potential mortgage lenders, providing you don’t rack it back up again.
Third Determination: Weighing in at 15% is the length of time your accounts have been active.
- 10% is determined by your eagerness to apply for credit. Continually allowing companies to check your credit does not earn you points so be cautious of that habit. The more inquiries you have, the lower your score will be dragged down. Mortgage lenders will be watchful as well, because to a lender this could be considered a lack of control with your credit and you may end up over your head in debt…. Not a ride they are willing to go on with you.
- 10% for the types of credit you have; the type of trade line or accounts you have. Credit cards and lines of credit are called revolving, meaning they can be used, paid down and used again. There is no specific end to this type of debt. An alternative to this is installment debt, which is set up with the end in mind. Car loans and student loans are an example of installment debt. Having a mix of both revolving and installment debt will earn you points in this category.
As mortgage brokers only have to check your credit bureau once to find a good fit with over forty lenders this is just one more reason why an experienced broker is an invaluable ally when you’re looking to arrange a mortgage and keep your credit score high.
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