During your homebuying process, you may encounter some peculiar terminology. “FICO” is one example.
This word, which is another name for your credit score, will affect the mortgage rate you get.
To set yourself up for success when buying your first home and avoid disappointment, it’s best to get up close and personal with your credit profile. Doing so ahead of time can help you anticipate what might hurt your chances at approval.
Here’s a breakdown of where to obtain your credit score and how to improve it before applying for a mortgage.
Table of Contents:
- Credit Scores in Canada
- Understanding Your FICO Score
- Top Tips to Improve Your Credit Score
- Are You in The Red Zone?
- Other Factors That Affect Your Credit Score
Credit Scores in Canada
Credit scores are used to determine creditworthiness. They’re based on an evaluation of a borrower’s financial history, including credit cards, vehicle loans, lines of credit, mortgages, and payment records.
The scores are designed to predict the likelihood that an individual will be able to meet their agreement and pay their bills on time.
A favourable credit score is a key factor in securing the mortgage rate of your choice. People with the most favourable credit scores have access to the most favourable prime mortgage rates. Higher scores also make it easier for an individual to get other loan products — sometimes with instant approvals.
The difference between a good and bad score can increase the cost of a loan by up to three percent or more. It’s wise to start working towards a high credit score earlier on so you can reap the benefits of lower mortgage rates later on.
In Canada, credit scores are generated by two nationwide credit monitoring agencies – Equifax and TransUnion. Both offer FICO (Fair Isaac Corporation) credit scores using the formula developed by Fair and Isaac, and each produces slightly different scores.
Understanding Your FICO Score
Five components comprise a FICO score:
- 35 percent of the total score is based on payment history
- 30 percent is the amount owed and the available credit, also known as credit utilization
- 15 percent is for length of credit history
- 10 percent is for types of credit used
- 10 percent is for search and acquisition of new credit and inquiries
Your FICO score moves up and down with each inquiry, balance change, and as your credit history evolves.
It is also important to understand that different lenders set their own policies and tolerance for risk when making credit decisions. That means there is no universal “cut-off score” used by all lenders to decide when to deny or approve credit.
That said, scores under 680 often don’t qualify for the lowest rates. Scores below 600 are deemed higher risk, and high-risk lenders typically charge higher interest rates.
Top Tips to Improve Your Credit Score
According to Equifax.ca, credit scores can range from 300 to 900. With 660 to 724 being considered good; 725 to 759 being considered very good; and 760 and up generally being considered excellent. Individuals with scores under 600 will have more difficulty getting credit, as they fall into the poor credit range.
To manage your credit score:
- Review your credit report at least once a year: Equifax and TransUnion offer online services for convenient access to your credit score.
- Correct any errors on your credit profile: Once you have contacted the credit bureau to file a claim, they will investigate the errors. You are also able to correct errors by filling out the appropriate paperwork.
- Apply for credit only when you need it: Applying for multiple forms of credit in a short amount of time may impact your credit score. However, if customers are rate shopping, they are typically given a leeway period up to 30 to 45 days. During this time, multiple inquiries generated for a search category may be counted as one inquiry — mortgages and car loans would count as separate search categories and would be considered two credit inquiries.
- Keep balances low: It is recommended that you keep your balances below 30 percent of your limit across all credit cards. Although, if you can manage even lower utilization your score can be better. Credit utilization accounts for almost one third of your FICO score.
- Pay off non-mortgage debt on time as quickly as possible: Pay off your credit cards with the highest interest first, and never miss a payment. Payment history makes up the highest scoring portion of your FICO score.
- Consider the impact of closing accounts: Closing a credit card account can shorten your credit history and increase your credit utilization. You may also lose precious points for this.
Are You in The Red Zone?
A red flag-raising applicant may be someone who:
- Has defaulted on their loans and/or credit cards
- Has repeatedly missed payments
- Has maxed out their credit card or cards
- Has applied for many forms of credit within a short period of time
Doing one or all of the situations above could deem you to be higher risk.
According to Equifax, “late payments remain on your Equifax credit report for seven years.” Missing just one payment can have a substantial impact on your FICO score. Therefore, it’s recommended that you don’t skip payments even if you are disputing a bill.
On the other hand, an ideal applicant may be someone who:
- Has paid all of their bills on time, consistently
- Has kept their credit card balances below 30 percent of their available credit
- Has only applied for new credit when they needed it
- Has a long credit history in good standing
Maintaining good credit behaviours can make you an ideal applicant.
Other Factors That Affect Your Credit Score
A credit score is not built overnight. You have to open and actively use a credit account for months before a credit score can be calculated.
Individuals typically start building their credit history by opening a revolving credit account. When applying with no credit history, individuals are generally more likely to be approved for these products. Revolving accounts are credit cards such as Visa, MasterCard, or retail store cards that allow you to make a minimum monthly payment and “revolve” the remainder of the balance over to the next month.
Research shows that consumers with longer credit histories have lower repayment risk than those with shorter credit histories. Also, consumers who frequently open new accounts have greater repayment risk than those who do not.
If you can maintain low balances, avoid frequently seeking credit, and make sure your payments are on time, your score should improve as your revolving credit history ages.
Not all inquiries count toward your FICO score. Requesting your credit score, promotional inquiries from lenders making pre-approved offers, lenders reviewing existing accounts, employee inquiries, and inquiries coming from insurance providers are not considered when determining your FICO score. These count as “soft inquiries”.
By contrast, “hard inquiries” will impact your credit score and may stay on your credit report for up to two years. These inquiries are generated when a lender requests your credit report during the loan application process.
Opening a new credit obligation usually negatively impacts your credit profile. Over time, however, this dip will decrease as you successfully manage your credit. It is recommended you apply for credit only when you need it.
Most negative information generally stays on credit reports for six years, according to Equifax. Although, some material may stay for even longer.
Negative information that will impact your credit score includes:
- Bankruptcy: This may stay on your credit report for at least six to seven years, depending on the manner of bankruptcy.
- Late payments: This will stay on your report for six years from the last date of the missed payment. Even if you eventually pay the balance owed, the information will remain on your report for the predetermined duration.
- Negative accounts: This can include foreclosures, which will stay on your report for six years from the last reported date of filing.
Active accounts that are being paid as agreed, are considered positive information. They will remain on your credit report as long as they are open. Once you close an account that has been paid as agreed and has no amount owing, it can still benefit your score for years.