There are so many things to consider when purchasing a home, not the least of which is how to go about obtaining a mortgage. You’ll need to figure out where your down payment will come from, how to get the best interest rate on your mortgage and whether your credit score is strong enough to be approved. This article aims to remove the guesswork by answering any questions you may have around your credit score and how it relates to your mortgage approval.
Will My Credit Score Affect My Mortgage Rate?
Having a low credit score can affect the interest rate you get on your mortgage, but perhaps not in the way you might think. When you get a mortgage with one of Canada’s large banks, the interest rate you’re given isn’t tied to your credit score. Generally speaking, if you qualify, you’ll be offered the same rates that all other customers are offered.
Having a low credit score becomes a problem if it leaves you unable to qualify with a primary mortgage lender, like a bank. In that case, you may be forced to apply with a trust company or a subprime lender who’s willing to take on clients with a less than stellar credit history.
Because of the perceived risk involved, the interest rate they offer could be substantially higher than what banks are offering. In other words, maintaining a high credit score gives you more options when it comes to shopping for the lowest rate.
What’s Considered A Good Credit Score?
Generally speaking, a credit score over 700 is considered good, while anything between 600 – 700 may be enough to qualify for a mortgage. Remember, there are other factors that go into the mortgage approval decision. Because credit score requirements vary between lenders, we like to consider the minimum requirements of the Canada Mortgage and Housing Corporation (CMHC), who provide default insurance on most mortgages with less than 20% down payment in Canada.
On their website, CMHC lists specific criteria for a minimum credit score. For example, they state that on any CMHC-insured mortgage, at least one borrower must have a credit score of 680 or higher. If you’re over 700, you should be in good shape as long as you’ve met all the other requirements.
How Can I Increase My Credit Score?
If you’re new to credit or your credit score is not where it needs to be, there are steps you can take to improve it. Here are a few general rules to keep in mind.
Keep Your Revolving Credit Balances Under 30%
If you have a balance owing on a revolving credit product, such as a line of credit or a credit card, try to make sure it’s always below 30% of your overall credit limit. For example, if you have a line of credit with a limit of $10,000, try to keep the balance owing below $3,000 at all times. The same goes for your Visa or Mastercard®.
Of course your best bet is to pay these balances in full every month, but that’s not always possible. As your balance owing moves closer to your maximum credit limit, your credit score will drop, as this demonstrates an inability to manage current debt levels.
Keep Credit Inquiries To A Minimum
Did you know that every time you apply for a loan or credit card or even sign up for a new cell phone plan, the corresponding credit inquiry lowers your credit score? This happens regardless of whether or not you end up proceeding with the product or service. There’s an understanding that most people will need to apply for credit from time to time, but if it happens too frequently, it may impact your ability to be approved for a mortgage.
Try to keep credit inquiries to a minimum. If there have been numerous inquiries made within a 6 – 12-month period, it’s not the end of the world, but you should avoid new inquiries going forward. As you continue to make payments on your debt each month, your credit score will improve, just keep the inquiries down.
Deal With Any Unpaid Collection Items
If you have an unpaid collection item or judgement showing on your credit report, you won’t be approved for a mortgage until it’s paid in full. Collection items are often the result of unpaid cell phone bills or speeding tickets. Even if you’re disputing these items, your best bet is to pay them upfront then fight your battles after the fact. Holding out on paying these debts will only hurt you in the long run, like when it’s time to get a mortgage.
Avoid Any Derogatory Credit Items
You know what they say – hindsight is perfect. Sometimes we get ourselves into trouble financially, either in ways that are self-inflicted or due to circumstances beyond our control. If you’ve had a serious ding to your credit in the past, such as a consumer proposal or bankruptcy, understand that it’s going to impact your ability to get a mortgage. If you have no negatives on your credit, do everything you can to avoid it. Just because you’ve had a consumer proposal doesn’t mean that you can’t get a mortgage, but you may be limited to working with a high-risk lender at a less than desirable mortgage interest rate.
Increase Your Savings
While your savings balance won’t display on any credit report, one of the things lenders look at when reviewing your mortgage application is whether you’ve demonstrated the ability to save money and establish a positive net worth. This is especially true the older you get. So, if you haven’t begun contributing to an RRSP or Tax-Free Savings Account, there’s no better time to start than now.
Having Good Credit Isn’t Everything
People often make the mistake of focusing solely on building their credit score while ignoring other important factors that go into obtaining a mortgage approval. Here’s a list of other criteria your lender will look at closely when reviewing a mortgage application.
Before your mortgage can be approved, you’ll need to demonstrate good job stability. The longer you’ve worked for the same employer – or at least within the same industry – the better. If your job is so new that you’re on a probationary period, you’ll need to wait until you’ve graduated and become a permanent employee.
Situations such as seasonal or part-time employment may be considered, but they’ll likely be subject to greater scrutiny. In addition to a recent pay stub, for example, you’ll be required to provide additional documentation, such as the previous year’s T4 slip or CRA Notice Of Assessment.
In addition to having good job stability, you’ll need to show your lender that you can afford the monthly mortgage payment. To figure this out, the bank uses two ratios: Gross Debt Servicing (GDS) and Total Debt Servicing (TDS).
Generally speaking, GDS measures your monthly housing costs, including mortgage principal and interest, heating and property taxes as a percentage of your gross monthly income. Ideally, that figure will not exceed 32%. TDS is a measure of your housing costs as well as any other monthly obligations, such as a car loan or credit card payment as a percentage of your income. The maximum allowable TDS is 42%, although your lender may be willing to go a bit higher depending on the circumstances.
Final Thoughts On Credit Scores And Mortgage Qualification
As you can see, having a good credit score is an important step toward obtaining a mortgage approval, but it’s not the only thing you need to think about. If you’re planning to buy a home in the near future, we highly recommend getting started with Edison Financial. With the right tools and the expertise to meet all of your mortgage needs, you can be assured that you’re starting off on the right foot.
Tom Drake is an authority in Canadian personal finance. He is a financial analyst and has been writing about personal finance since 2009 at the award-winning MapleMoney. His work has appeared in MintLife, Canadian MoneySaver, and U.S. News & World Report, and has been quoted in The Globe and Mail, Yahoo Finance, and Financial Post.