- That you need to educate yourself.
The most important thing you need to know about credit is that you need to know about your credit. Most people know very little about their credit; in fact, many don’t even understand the word. I get a lot of applications from people who were denied mortgages because they simply had no idea what was required in order for them to qualify. They weren’t delinquent or bad people; they were just ignorant. This post is a very bare start. Hopefully, it will stimulate you to take action if you’ve only been sitting on the sidelines until now. At the end, I will refer you to a book to learn more.
- Credit means many different things.
From the standpoint of qualifying for a mortgage, the word “credit” is shorthand for your track record of responsibility in paying off your debts. Your “credit” really means “credit-worthiness.” A good credit history means you’re a good risk for a mortgage.
Your history is tracked through several agencies (called “credit bureaus”) and the lenders rely on their reports in determining whether you are an acceptable risk. In Canada, there are two major credit bureaus, Equifax and TransUnion.
“I think I have good credit, I always pay everything in cash, don’t use credit cards,” is something I hear far too often.
The fact is, in this case, you do not have good credit, you have no credit. You are a long way from qualifying for a mortgage. If you’ve never had any debt obligations, you have no history of being responsible in paying your obligations—at least that the bureaus are aware of. Therefore, you are not a good credit risk to the lenders.
- You need a high credit score to be approved for a mortgage.
Your credit score is the aggregate rating of all the reports submitted to the bureau monthly. These reports are run through algorithms that create a composite score. Who provides data for these scores? Almost anyone from whom you’ve accessed credit: credit card companies, vehicle and home loans, payday loans, phone companies, collections, etc. For the most part, landlords do not report, however.
Scores range from 300 (extremely bad) to 900 (extremely good.) The higher the loan-to-value ratio of the mortgage for which you are applying, the higher your score needs to be. Typically, a 620 score will be required for an 80% LTV mortgage, a 680 score for 90% and a 720 score for a 95% LTV mortgage. At Fraser Valley Rent 2 Own, we coach you to reach a 700 score for a 90% LTV mortgage (to go beyond the minimum and be safe).
Many people are aware that they need a good credit score to get a mortgage; many are not aware, though, that the score is only one of many indicators; there are many other things that your report needs to show, to qualify for a mortgage.
- The rule of 2-2-2
In addition to having a high credit score, you need to satisfy the so-called rule of 2-2-2. This means that you need to have a minimum of two active credit lines showing on your report (more is better, though), that those two lines need to have a minimum of two years of history, and that they need to have unsecured limits (in the case of revolving credit) of at least $2000 or a highest original value of $2000 (in the case of installment or open credit). Those limits, though, do not need to be two years old, so long as they are that high when applying for a mortgage.
- You cannot get a mortgage if you do not have a credit card.
Its that simple: no credit card, no mortgage. At least one of your two credit lines must be “revolving credit,” meaning that the payment is not fixed but that you can pay off as much or little as you want every month, so long as you satisfy a very minimal requirement. Revolving credit best indicates your responsibility with paying back your loans (credit card debt is simply a loan from the card issuer).
The second credit line can be another credit card but can also be installment credit (such as a vehicle loan), open credit (such as a cell phone bill—but that will not likely meet the $2000 requirement), or a retail account.
Having a credit card is not bad, as some people think; being irresponsible with a credit card is bad. If you cannot be responsible with a credit card, then resign yourself to being a renter for the rest of your life. When credit counsellors tell you to cut up your credit cards, they’re assuming you’ve already resigned yourself to never owning a home.
- Know what’s on your credit report.
Did you know that anyone can check their own credit score and report, for free? When you apply for a mortgage—or any loan, for that matter—the lender will need to check your report, and you will have to give them permission to do so. Each time they check, that will also be reported to the bureaus. Those checks are called “hard hits” and actually damage your score a little, so you want to be careful how often you give them permission to do so.
But you can check your own score, for free and without collateral damage. When you check your own score, these are “soft hits” that do not hurt you. While Equifax and TransUnion may charge you a fee to provide your score and report, there are other companies with whom they are affiliated who will use their data to give you your score and report for free. Borrowell (www.borrowell.ca) is affiliated with Equifax and uses their data and CreditKarma (www.creditkarma.ca) is affiliated with TransUnion and uses their data.
Why should you check your own scores and reports? In short: to be aware, to avoid unnecessary hard hits, to correct errors, and more. We’ll discuss this and a lot more in next week’s post when we pick up the remaining 6 reasons (or more) that you need to know about credit.
I’ll also refer you to the best book on the subject, to learn more.