A borrower’s credit history is pivotal when applying for a mortgage. Credit agencies use propriety methods when determining your credit score. Let’s dive into Credit 101.
Lenders use credit reporting agencies to determine a borrower’s loan repayment ability. Equifax® and TransUnion® are Canada’s credit bureaux. Lenders will subscribe to one or the other, and each report may differ.
The role of these agencies is to report on creditworthiness. It is the responsibility of the credit issuer, such as Visa®, MasterCard®, AMEX®, Ford®, and Rogers®, to name a few, to report up-to-date information to the bureau.
Credit agencies do not actively look for new information about each of your accounts, and the two agencies do not work together or share information. Outdated info, for example, if all of your financial products (Credit Cards, Loans, Accounts, etc.) are with one bank, you may not have a credit history with both agencies, just the one that bank subscribes to. This may limit our options and is one of the reasons financial experts do not recommend having all your financial products with a single institution.
Payment history is the most important factor in your credit score because it shows lenders how you have previously managed your debts. A history of consistently late or missed payments can make getting approved for a loan difficult and may result in higher interest rates.
Amount owed or credit utilization ratio is the second most important factor in your credit score. To calculate it, add up the credit limits for all your credit products and divide by the total amount of debt you owe. This number represents how much of your available credit you’re actually using. Lenders see high credit utilization ratios as a sign of risk, even if you always pay your balance in full and on time.
The length of your credit history is an important factor in your credit score. It’s generally good to keep your older accounts open and active. That said, there may be a time when it’s worth closing an older account. For example, if you have a credit card with an annual fee that you no longer use, it may make sense to close the account.
Having multiple types of credit products is generally better for your score than only having one. This shows that you can handle different types of credit responsibly. For example, having both a credit card and an auto loan can show that you can manage both revolving and installment debt. Additionally, having a mix of revolving and installment debt from different institutions can help establish your credit on both credit reporting agencies.
Inquiries are recorded on your credit report whenever a lender or other party requests your credit report from a credit reporting agency. While it’s normal and expected to seek credit every so often, too many inquiries on your credit report can cause concern among lenders. It might appear that you’re desperately seeking credit or trying to spend beyond your means without the ability to repay the money you want to borrow.
Credit scores, which place a rank or numerical value on the report, range from 300-900. Each credit agency will calculate its score using its proprietary method, meaning the Equifax score will vary from TransUnion.
Lenders will have a minimum score, which may differ for each lender. Typically lenders will require a minimum score between 600-640, while higher scores will gain access to lower rates and more significant mortgage amounts.
It is important to understand credit scores and their role when making a major purchase or financial decision. Speaking with a mortgage professional can help address any credit issues before they arise and ensure a smooth mortgage transaction.
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