It takes credit to build credit – most of us have heard this at some point in our early years of adulthood. Some of us heard it when we got our first credit card; others when they went to apply for a loan of some type and realized they didn’t have a credit score. The crux is that while it takes credit to build credit, it also takes credit to destroy credit. So, what exactly is “credit” when it comes to finances, and does your credit score impact your mortgage rate?
Credit is essentially a numbering system that gauges how likely you are to repay borrowed money. The higher your score, the ‘safer’ you seem to lenders, and the lower your score, the ‘riskier’ you are.
The first step to building your credit is to get a credit card. Credit cards typically carry a high interest rate and can be a bit of a risk if you use them too freely without considering that you have to pay it off afterwards. However, by having and using a credit card and then paying off your balance in part or in full each month, you show the lender that you are likely to repay your debts. This helps to increase your credit score. In addition to making payments on time, it is essential to keep balances low as this shows the lender that you aren’t spending more than you’re able to pay back.
What if you pay rent?
You can also improve your credit score by paying rent. There are several programs that use your monthly rent payment to boost your credit rating, as long as you pay your rent on time. These programs typically either require landlord verification, or that you make rent payments via their platform. Some may even verify rent payments using electronic bank records. These programs can help demonstrate a positive credit history, as a cost as low as $5 per month.
What if you have student loan debt?
Debt is debt, and as long as you’re making payments on time, your credit rating shouldn’t suffer. With that said, carrying too much debt will impact the amount of mortgage you qualify for. Here are a few things you can do when applying for a mortgage with student debt:
- Pay off other debt. Even seemingly minor credit card debt will impact your debt-to-income ratio. Paying these off ASAP will improve your mortgage affordability.
- Restructure your student loan. Debt ratios are based on monthly payments. By restructuring your student loan to extend payments over a longer period of time, you’ll reduce your monthly obligations and positively impact your debt ratios. However, it’s worth noting that you’ll pay more in interest over time.
- Make regular student loan payments. Showing you’re responsible and can handle your debt responsibilities will improve your credit score.
- Get pre-approved. If you aren’t sure about whether you will be able to get a mortgage with student loan debt, apply for pre-approval. This will give you a set mortgage amount and interest rate so that you know what you can afford.
Next, it is important to understand your credit score. In Canada, a credit score ranges from 300 to 900. A higher score is always desirable, but any score between 743 and 789 is usually considered good, and anything over 790 is very good. A score between 693 and 742 is considered ‘fair.’ Anything below 692 is considered ‘poor,’ which means you may have a more challenging time getting lenders to loan you money. These ranges are different when applying for mortgages and getting a reasonable interest rate, as you will read more of below.
In Canada, a credit score is determined by multiple factors: payment history, used vs available credit, credit history, public record, and inquiries. These factors are weighted at different amounts, with payment history usually carrying the most weight and the number of hard credit inquiries carrying the least weight.
Does your credit score impact your mortgage rate?
Many wonder if and how their credit score affects their ability to buy a house. The simple answer is yes; it absolutely affects your mortgage interest rate. The higher your score, the lower the interest rate you will usually get – and when you’re talking about a loan that is hundreds of thousands, if not millions, of dollars, a percentage or two makes a big difference.
Generally, a credit score of 760 or higher will give the borrower access to the best mortgage rates – as long as they have consistent income and meet the lending criteria such as the mortgage stress test. A credit score between 650 and 759 will moderately impact the mortgage rates available to you, but you may still have access to all mortgage rates available on the market. This is especially true if you have other factors on your side, like a hefty down payment.
As your credit score drops, so does your access to better interest rates. While in the past, a score above 680 was the minimum credit score requirement, Canada Mortgage and Housing Corp. (CMHC) dropped the minimum credit score requirement from 680 to 600 as of July 5, 2021. While this is good news for those who may be rehabilitating their credit score or those just starting to build credit, it doesn’t guarantee they will have access to the best mortgage rates. In fact, with a score below 680, the borrower will see rates incrementally increase. Typically, borrowers with a credit score of 600 would be considered “non-prime,” which means their mortgage rate would normally be about two percentage points higher than a “prime” borrower.
With a credit score of less than 600, it is almost impossible to get a mortgage from a bank in Canada. This is where B lenders and private mortgage lenders come into play. There are plenty of private mortgage lenders across the country with no minimum credit score requirement – this isn’t necessarily the best thing if you’re looking for a reasonable mortgage rate. Many private mortgage lenders will charge an interest rate substantially higher than the prime rate or even the non-prime rate that a bank will offer. These lenders may also tack on extra fees due to the borrower having poor credit as it gives them a type of insurance in the instance that a loan is defaulted on.
If you are thinking of buying a home soon, it’s a good idea to track your credit score and start working toward improving it, if necessary.
When you’re ready to buy, ensure you work with an experienced, professional real estate agent who can help you navigate the market. Click HERE to find a RE/MAX agent near you.