In the last blog post, we talked about the variety of credit scores out there and the muddle that that reflects.
The bottom line, however, is that they all work generally the same and the process for building your score is the same, regardless. What applies to one, applies to all.
Let’s look first at how your score is made up. There are five contributing components:
- Payment history – 35%
Lenders want to know whether you have been responsible with paying back previous loans, so this makes up the biggest portion of your score. Do you pay your loans off, and do you make your payments on time? Both the number of late payments and the length of the delinquency will hurt your score, but every single one will have somewhat of an impact. In the end, you will need an absolutely clean record for 1 – 2 years to be approved for a mortgage.
- Debt you currently owe – 30%
If you have high outstanding debt, you will be a greater credit risk and your score will go down. However, the score is based not only on how much you owe, but on how much you owe relative to how much you have been approved for. If you have a high approved amount, it means that you’ve already been judged capable of supporting that. If there is a lot of room between your current outstanding debt and your approved maximum, then you are a good credit risk and it will build your score. If you are near your limit (measured proportionally), you are a poor credit risk, regardless of the total amount owing, and it will negatively impact your score.
- Length of credit history – 15%
Time is a great builder—and healer–of credit scores. If you have a long history of established credit, that will help you. A short one will contribute less to building your score
- New credit – 10%
Brand new credit will not help build your score immediately, but new credit lines will build your score as they begin to age and you show a history of responsible repayment. Credit inquiries, though, will hurt your score, because they may reflect that you are shopping around for credit, perhaps “borrowing from Peter to pay Paul,” as the saying goes.
- Types of credit – 10%
Revolving credit (e.g. credit cards) are the most valuable, installment credit (e.g. vehicle loans) are second best, and retail credit or open credit (e.g. cell phone bills) are least important contributors to your credit score. Sometimes, lenders like to see that your credit lines are of different types.
So, what can you do to build your credit?
- Use credit. If you never use credit, there is nothing there to show whether you are responsible or not with loans; it doesn’t matter how rich you are. Some of the richest people in the world cannot get mortgages because they don’t use credit. If you deal only in cash, you will not get a mortgage.
- Always pay at least the minimum amount required and make your payments on time, every time. This cannot be emphasized enough!
- Keep your credit balances (on credit cards, for example) below about 50%. Below that, it shows that you have plenty of room for more credit, and your score will go up; above that, it suggests that you are a high risk because you are maxing out the credit available, and will hurt your score.
- Never cancel a credit card, just stop using it if you no longer need it. (This assumes that you can be responsible with credit; if you can’t, then get rid of it, but then don’t expect to build your credit score either, or ever qualify for a mortgage; Give up that dream!)
- Don’t shop around for credit. Limit the number of credit inquiries to 1 or 2 per year.
- Pay off any collections or judgements that may have hit your report; these have a huge negative impact on your score.
- Correct any incorrect information on your credit report.
- Avoid bankruptcy of a consumer proposal; there are other ways to reduce overwhelming debt.
- Work toward the “Triple two” rule of thumb: You need at least two credit trade lines (at least one must be a credit card), with at least two years of good standing, and with minimum unsecured limits of $2000, in order to qualify for a mortgage.
If your credit score is under 680 or you do not meet the triple “two” rule of thumb, Rent 2 own is a great way to go to get into home ownership. It buys you the time, and sets you up with a program and ongoing coaching, to reach those bench marks.
What is the lowest score you need in order to qualify for rent 2 own? The answer may surprise you: it is 0. (The lowest possible credit score is 300, but if you don’t have any profile, it is effectively 0. Establishing a profile already brings it up to 300.)
How long will you need to be in a rent 2 own program in order to qualify for a mortgage? Realistically, almost any credit can be built up to reach 680 in about three years if you are truly serious and take responsible action with building your score. Because of the “Triple two” rule, the minimum period is usually two years, unless you already have a strong head-start.
Each report is unique and there are numerous intricacies that may require interpretation by an expert, but everyone can work on the basic ingredients for improvement. Get started ASAP. There is no better time to start working on it than today.