We’ve all been there. That moment when we stare at the debt on our credit card statement and think, “How am I ever going to afford a house of my own?”. Your credit score may not be in the best shape due to your car breaking down, having to replace a big-ticket item, getting laid off from your job, or not being frugal on your shopping sprees. Regardless, I hate to say it, better credit scores equal better mortgage rates. And they are also the first thing mortgage lenders will look at in your application. Before you start shopping around for a home, let’s fix that financial hiccup to ensure you get pre-approved for a mortgage while securing a lower interest rate.
A credit score is a 3-digit number that represents your credit information at one point in time. It is an indication of your financial responsibility. Private mortgage lenders and banks use it to consider what loan you may qualify for or if you qualify for a mortgage loan at all. Some people are surprised to learn that an unpaid cell phone bill from 6 years ago is still showing on their credit history and is damaging their rating. Also, you’ll have to resolve any errors in a credit file that have occurred.
How is your credit score calculated?
- Payment history: Payment history makes up roughly 35% of your credit score. As the name suggests, this is how you’ve been making payments towards your credit, loans, and bills. Are they on time? Are you only making minimum payments? Have you ever missed payments? Many Canadians believe this is the only factor that makes up your credit score. While it is a big part of it, it’s not the only contributing factor to your score.
- Outstanding debt: Also known as credit utilization, this is the amount of debt that you owe. This also makes up about 30% of your credit score. Ideally, it’s best to keep your credit at 0, or at least far lower than what your credit limit is. Let’s say your credit card has a limit of $5,000. If you consistently have your balance around $4,800, that isn’t good for your score – even if you make the minimum monthly payments.
- Credit history: Separate from payment history, credit history is the length of time you’ve had credit. Making up about 15% of your score, the longer you’ve had credit, the better it is for your score.
- New credit: When you apply for different types of credit, this is called new credit. It makes up about 10% of your score. If you apply for too many different types of credit in a given year, it can impact your credit score.
- Credit mix: Making up 10% of your score, credit mix is the variety of different credit types you have. This shows lenders how you can balance having different types of credit. It’s a good thing to have a credit mix (credit cards, line of credit, car loan, etc.) as your score may be lower if you only have one type of credit.
Why do you need a good credit score to get pre-approved for a mortgage?
A lender isn’t just going to hand you over money and trust you to pay them back. You have to go through a pre-approval process to make sure that the lender will get their monthly payments. After all, they are the ones investing in you. If your credit score is lacking, then they won’t have much trust that you’ll repay their money and you won’t get pre-approved for a mortgage. That’s where I can help. Together, we’ll get your application ready (for free) to prove to the lender that you’re not a risk.
What’s a good credit score to get pre-approved for a mortgage?
The minimum credit score you want is 680. Having a credit score of 750 is considered excellent. A high credit score indicates to lenders that lending you money for a mortgage is a low-risk investment for them. When your credit score is low, it tells a mortgage lender that you might default on your loan payments.
And remember, not only do you have to pay your monthly mortgage fees, you have to take into consideration a 5% – 20% down payment. If you can’t prove to your lender that you are able to pay your loan in a reasonable amount of time, they will think you are a risk and you won’t get pre-approved.
The lender will look at your credit by evaluating:
- How long you have had a credit card
- If you miss payments;
- Whether you stay close to your credit limit;
- The number of times you have applied for credit and how often;
- The size of any outstanding debts.
How to improve your credit score
You have the chance to improve your credit score to lock in a pre-approval and start your house hunt.
- Pay your bills on time and pay more than your monthly minimum, or pay in full
- Use no more than 30% of your available credit card limit
- Limit how frequently you apply for credit. The longer you’ve had a credit account open, the better it is for your score. If you decide to transfer an old account to a new account, that new account is going to be considered new credit.
- Review your credit report for any errors that have been reported and signs of identity theft
Other options if you can’t fix your credit score
There are other options if you can’t get approved through a traditional lender. A vendor take-back mortgage (VTB) is a type of mortgage where the seller offers to lend funds to the buyer to help them purchase the property. You can negotiate with the seller on interest rates, payment options, etc.
You could also get someone with a good credit score to co-sign your mortgage to increase your probability of getting pre-approved. Just remember, if you can’t make your payments on time, then it will impact the co-signer’s credit score not just your own.
You should also follow these rules:
- Avoid requesting multiple mortgage applications with different lenders within a short period. Ideally, shop for mortgage rates within 30 days of when you plan to buy a home.
- Avoid applying for other loans, such as a car loan, as this may increase your monthly payments.
- Make all existing credit and loan payments on time and in full.
If you’re worried that your less-than-stellar credit score may prevent you from your dreams of homeownership, let’s connect. As an experienced mortgage broker in Barrie, I specialize in helping those with no credit rating or low credit scores find the right mortgage solution. Call me today at 705-315-0516 and let’s get started.