Understanding your credit score
by Jeff Hui
Before lenders decide on the rate at which they offer you a mortgage, they want to know two things about you: your ability and your willingness to pay back the mortgage. For the first factor, they assess your income to debt ratio. To determine your willingness to repay the mortgage, they examine your credit score.
Your credit score is between 350 (high credit risk) and 850 (low credit risk). A good credit score enables you to finance large purchases such as a home, business, automobile, renovations, electronics, and large home appliances at lower interest rates. By understanding what makes a good credit score, you can start on the path to greater financial freedom.
Credit scores only consider the information in your credit profile. They do not consider your income, savings, down payment amount, or demographic factors such as gender, race, nationality, or marital status. The credit score takes into consideration the factors relevant to an individual’s willingness to repay a loan.
The data for your credit score is compiled from banks, retailers, and other lenders.
The most important thing is to know your credit score and to ensure that your credit history is correct. For a small fee, you can quickly get your credit score and report from Equifax (www.equifax.ca).
There are five factors that make up your credit score, and each factor weighs differently. Here’s the breakdown, along with some tips to help strengthen your score:35 per cent—Payment history: Payment history is the largest component of your credit score. It reflects how consistently you pay your bills on time. Late payments, collections, past due accounts, and public records such as bankruptcies can seriously hurt your score.
30 per cent—Amounts owed: Amounts owed takes into account how much is owed on all your accounts, how many accounts you have that carry a balance, and the percentage of available credit that you are using. Keep credit card balances under 50 per cent of the available limit at all times, and when preparing to make a large purchase, bring those balances down to under 30 per cent at least three months before applying for a mortgage. 15 per cent—Length of credit history: This factor considers how long you have had credit, the length of time each account has been open, and the time since recent account activity. Accounts that have been active for 10 years are very good, whereas accounts that are six months old aren’t as good. When applying for a mortgage, consumers should keep long-standing accounts open because it will help increase their credit score. 10 per cent—New credit: This factor includes the number of recently opened accounts, the number of credit inquiries, and the amount of time each account has been open. This portion of the score also examines how often you apply for credit. When applying for a mortgage, it is best that you do not open or apply for new credit accounts. When shopping for a new mortgage or auto loan, it pays to plan ahead so that you do all of your shopping within a focused period of time.
10 per cent—Types of credit used: A variety of credit is the best way to develop a good score. The most important consideration is to be selective about the type of credit you apply for because this can improve your score. To the scoring system, third party financed credit cards, such as department store credit cards, are generally considered low quality credit because the holder of these third party cards may appear desperate for credit.
Your credit report must contain at least one account that has been open for six months or more and at least one account that has been updated in the past six months for you to get a credit score. This ensures that there is enough information in your report to generate an accurate score. If you do not meet the minimum criteria for getting a score, you may need to establish a credit history prior to applying for a mortgage.
Your credit score is very important to your financial health and to the stability of your financial future. A strong credit score will help you finance large purchases at the best possible interest rates. A few simple changes now can lead to thousands of dollars in savings over the life of your mortgage. Take control and start making the necessary changes today to ensure a strong financial future for you and your loved ones.
Jeff Hui is a mortgage consultant with Mercury Mortgages and can be reached at jeff@mercurymortgages.com or 905-273-4234.
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