If you’re planning on buying a home in the near future, you’re likely going to be applying for a mortgage.
But before a lender will finance your real estate dreams, they're going to want to make sure you’re good for it. They need a quick, easy way to see if you've been good at paying back debts. That’s where your credit score comes in.
Your credit score may not be the only factor lenders consider on a mortgage application, but maintaining a good score is key if you’re hoping to get the mortgage you want, with favourable terms. It can even make or break your application altogether, in ways you may not expect.
Case in point: a friend of mine was financially responsible, with good income and lots of savings, and yet when he applied for a mortgage on his first home, he was denied because he lacked a credit score. With the 2008 crisis still fresh in his mind, he was spooked by the idea of credit and stayed away completely. This may have helped him stay out of debt, but it also meant he had no credit score – and to a mortgage lender, no credit is almost as damning as bad credit.
In this article we’ll discuss what a credit score is, how it can be damaged, and various ways to improve it before you apply for a mortgage or mortgage pre-approval.
What is a credit score and how do you get a bad one?
Your credit score is a 3-digit number assigned to you by the two Canadian credit bureaus, Equifax and TransUnion. The number falls between 300 and 900 and, as you may expect, the higher your credit score, the better.
This number is intended to represent your overall quality as a borrower. A good score is attractive to mortgage lenders because it suggests you pay back money that you owe, and you do it consistently.
A score of at least 680 is considered good by lenders, but to play it safe, aim for at least 700, as your score will fluctuate based on your daily credit behavior, and you wouldn’t want it to dip below the optimal level right before you apply for a mortgage.
I wish I could tell you precisely how the credit bureaus calculate your credit score, but they don’t disclose exactly how it’s done. That’s because they don’t want borrowers to have complete control over their score – it should reflect your long-term habitual behaviours, not just a few deliberate actions in the weeks preceding a loan application. What we do know is that there are five key factors that most impact your credit score.
Your Payment History
Lenders want to see a steady payment history. In fact, of all contributing factors, your payment history has the biggest impact on your credit score.
Remember that time you forgot to pay your cellphone bill on time? It probably didn’t help your credit score. Late and partial payments on any credit cards, loans or other bills will count against you. Likewise, if any of your debts are written off or sent to collections, or if you’ve ever filed for bankruptcy, your credit score will take a serious hit.
The Length of Your Credit History
Lenders also want to see that you have a long track record of using credit responsibly. Someone who has had credit cards and other credit accounts open for 10 years has proven themselves as a borrower more than someone who signed up for a credit card last week.
As such, how long you’ve had credit accounts open matters, and cancelling credit cards will lower your score.
Your Available Credit
After your credit history, the factor that matters the most is your available credit. Not to be confused with your credit limit, your available credit is how much money you can borrow at a given time.
Your available credit is calculated by taking your credit limit and subtracting any balances you’re currently carrying. For example, if you have a card with a credit limit of $4,000 and another with a limit of $6,000, your total available credit is $10,000. If you rack up more than $3,500 ($35%) worth of purchases on those cards at any given time, it will be reflected in your score.
Using less than 35% of your available credit suggests to lenders and credit bureaus that you’re a responsible borrower. For this reason, lowering your credit limits can actually hurt your score, even though it can seem like a responsible thing to do.
The Number of Credit Inquiries
The third factor influencing your score is the number of times you’ve initiated credit inquiries, which are exactly what they sound like: requests to obtain information on your credit.
There are two types of credit inquiries: soft hits and hard hits. Soft hits don’t count towards your credit score. The most common example is requesting a copy of your own credit report.
Hard inquiries do impact your credit score. The most common example is applying for credit, such as a mortgage or credit card. Too many hard inquiries within a short time period makes lenders nervous and can lower your credit score.
Last, but not least, the types of credit you have matters. Lenders don’t want to see just one type of credit; a variety helps demonstrate that you can manage all kinds of debt responsibly, and that you can balance priorities. This also suggests to lenders that you’re likely to be able to manage a mortgage on top of your other expenses.
How do you find out your credit score?
Where can you get a credit report or credit check?
If your credit score is your overall grade, your credit report is your report card. It’s an overview of all the various components of your credit and credit history. This distinction is important because lenders don’t just look at your credit score. They also examine other aspects of your credit, including your payment history, total household debt, unpaid debts, and the number of open credit accounts.
It’s a good idea to review both your credit score and credit report at least once a year, especially before buying a home, as this will help you avoid any nasty surprises. If your score needs improvement, this will give you some time to fix it, and if your report has inaccuracies, you can take the necessary steps to get them corrected.
To get your credit report and credit score, you’ll need to go to the two Canadian credit reporting agencies, Equifax and TransUnion, who track your credit history. As a citizen, you’re entitled to receive one free copy of your credit report each year from these agencies. Equifax and TransUnion both have interactive phone services as well as downloadable forms on their respective websites.
Once you have your free annual credit report, subsequent requests may come with a charge, though some fintech (financial technology) firms like Credit Karma and Borrowell also offer free credit reports. It’s a good idea to get into the habit of regularly checking your credit report to ensure it doesn’t have any inaccuracies (we’ll discuss this later on).
Unlike your credit report, you aren’t entitled to view your credit score for free once per year, although some fintech companies are offering this service for free as well.
Another advantage of regular credit checks is preventing fraudulent activity. With Equifax’s recent data hack, where the personal data of thousands of Canadians was potentially compromised, we were all reminded that keeping a watchful eye can help ensure no one is using your identity in a fraudulent way.
What do you need to have in order to get a credit score?
A credit score is considered personal information, so the credit bureaus, Equifax and TransUnion, won’t give it away to just anyone.
You’ll need to verify your identity by confirming personal data such as your SIN, address and full name.
When you go through this process, you may discover that you have what is known as “thin credit.” This means your credit history isn’t long or in-depth enough to establish a credit score. In this case, you can start building up credit by, for example, applying for a credit card.
Equifax vs. TransUnion -- what’s the difference?
As mentioned, Canada has two major credit bureaus: Equifax and TransUnion. Although they use the same scoring scale, 300 to 900, they actually calculate credit scores in slightly different ways, so your score is likely to be a little different at each. For example, one credit card where you’re carrying a balance could appear on your Equifax credit report, while it doesn’t appear on your Transunion report, lowering your credit score with Equifax.
The idea that all lenders report to both Equifax and Transunion is a common misconception. Although many do, lenders have the option to request credit reports with either credit bureau, and some lenders report only to one because of the cost of putting in requests.
What this means is that your credit score could actually be different from one lender to the next. It’s best to clarify with your lender or broker which agency is being used.
How do you read a credit report?
Whether you’re looking at your credit report for the first time or the 12th time, it can be confusing if you don’t know what you’re looking at.
Although the credit reports for Equifax and TransUnion are slightly different, they have similar content. Your report can include personal information, financial data, and information on your credit health, such as records of non-sufficient fund (NSF) payments, debt sent to collections and liens.
Although you’ll want to review all sections of your credit report for accuracy, you’ll want to pay close attention to debts. The credit bureaus have a scoring system to show the type of debt and its current status.
For example, if your debt is marked as “I,” it’s an installment payment with regular payments in a fixed amount, (common for car loans). “R” indicates revolving credit, which allows you to borrow money up to a certain amount, such as a credit card. “O” stands for open status, or credit up to a certain limit that isn’t revolving, such as a line of credit. “M” stands for mortgage.
Once you identify the debt type, review its payment status. There’s another scoring system that ranks debt from 0-9. A score of one means that the debt has been paid within the agreed upon terms, a score of two means the payment is 31-59 days late, and a score of nine indicates it’s been written off as bad debt. These numerical values are combined with the letter-based ones above to create scores like “R1”, which would denote revolving credit that has been paid on time within the agreed-upon terms. You can view a full list of the credit scoring definitions here.
For a more detailed explanation of the individual credit reports, visit the Equifax and TransUnion websites.
How can you fix inaccuracies on your report?
It’s good practice to request a copy of your credit report at least once a year, not only to know where you stand, but also to verify that that your personal information is up to date and your financial information is accurate.
If you see any inaccuracies, you have the right to file a dispute with Equifax or TransUnion immediately to correct it. Remember to check credit reports with both bureaus, since the information they’re working with can be slightly different.
Common inaccuracies include someone else’s information on your credit report, debts that aren’t yours, debts that you’ve already fully paid off, and incomplete payment history. If you’re planning to apply for a mortgage, request a copy of your credit report at least six months in advance, as mistakes like these can impact your ability to qualify for a mortgage with the best terms.
Both Equifax and TransUnion have different dispute resolution processes. You’ll typically submit something in writing to indicate you don’t agree with an item on your credit report. If you’re not satisfied with the resolution process or believe the information in dispute is still incorrect, you can add a special note to your file with an explanation as to why you disagree.
How to rebuild your credit score once it’s damaged
Before lenders will approve your mortgage, they’ll want to see that you have a track record of paying back borrowed money on time and in full. Your credit score tells them this.
This isn’t the only factor lenders consider (your income, down payment, your personal debt and the property you’re buying, all matter, too), but a low credit score can make it tougher for your mortgage to be approved with favourable terms.
For example, a poor credit score could lead your lender to offer you a higher mortgage rate. This can cost you a substantial amount of money over the life of your mortgage. Most prime lenders (banks and other financial institutions that lend funds to consumers) want a credit score above 700. If your credit score is between 600 and 700, the rest of your mortgage application must be strong to achieve a good impression overall.
If your score is below 600, you’ll likely need to seek out mortgage options from alternative lenders, such as trust companies and private lenders, who will likely charge a higher mortgage rate. This is often a temporary measure (1-2 years) while your credit rebuilds and you can switch back to a 'prime' lender.
If your credit score is damaged, there are several ways to build it back up, but it takes time. There are companies that promise to repair your credit score overnight, but those are most likely scams. By taking the slow and steady approach and exhibiting good credit behaviour, you can be on your way to repairing your damaged credit score.
Step 1: Pay off your outstanding debt.
If you’re carrying a lot of outstanding debt, the best way to improve your credit score is to pay it off. Lenders want to see a credit utilization rate below 35%, so aim to get it below that threshold by paying off as much of your outstanding debt as you can.
As a general rule, you never want your credit utilization rate to be over 80%. So if you have a $10,000 credit card, you should never go over an $8,000 balance. In this example, if you routinely put more than $8,000 on your card, increase your limit in order to stay within that 80% range.
There are two particularly effective ways to pay down debt. The first is the debt avalanche method, in which you pay off the debt with the highest interest rate first. This helps you save money by paying less interest overall.
The second is the debt snowball method, in which you pay off the debt with the smallest balance first. This helps you knock sources of debt off your list, which many find beneficial in staying organized and managing stress. It can be particularly effective when you have a small remaining balance but a high payment. By getting rid of the larger monthly expenses, that frees up cash flow to pay down other debt faster.
Choose the method that’s most motivating for you.
Step 2: Start paying off credit cards and bills in full and on time.
If you don’t already, start paying all of your bills on time and in full, from your cable bill to your car loan. If you damaged your credit score by defaulting on credit and filing for a consumer proposal or bankruptcy, one of the best ways to improve it is by responsibly using a credit card and paying it off in full and on time.
The most effective strategy is to set up automatic payments for everything to eliminate the risk of forgetting to make a payment on time.
Showing positive credit behaviour can go a long way in establishing the credit score you need to obtain a mortgage.
Step 3: Make at least the minimum payment.
If you run into a situation where you can’t afford to pay credit card or loan payments in full, at least make the minimum payment. This will help keep your credit account in good standing.
Even if you’re focusing on Step1, be sure to make the minimum payment on all outstanding debts in order to avoid further damaging your credit score while you’re trying to build it back up.
Step 4: Use credit cautiously.
Consider using your debit card for your daily purchases and using your credit card only for certain regular purchases, such as gas and groceries. You’ll lessen your temptation to overspend, which can be valuable especially if you’ve accumulated debt by living beyond your means.
Sometimes when your credit score is damaged, you won’t qualify for a regular credit card. In cases like this, you might consider signing up for a secured credit card. With this type of card, you’ll likely be required to make a deposit in the amount of the available credit you’d like. For example, if you apply for an available credit of $1,000, you’d make a $1,000 deposit. By using your secured credit card responsibly (paying it off in full and on time), over time you can help build a positive credit score.
Step 5: Keep old credit cards.
Mortgage lenders want to see that you have a history of effective credit management. In essence, you want to prove that you've had access to debt for many years and have managed properly. They call this a 'trade line' and it can be pretty much any source of debt.
But credit cards are a particularly good trade line. Why? If you get a car loan, eventually you need to pay it off, which means your trade line disappears. That's bad. Plus, with a car loan you're paying money in interest. That's double bad.
A credit card is a good trade line for two reasons:
1) It can last for your entire life, and
2) if you use it properly (meaning, use the credit card to cover all your day-to-day expenses and pay it off within the 30 day grace period) you pay literally $0 in interest, ever. That's good.
If you sign up for a new credit card, there’s no need to cancel your old one, even if you don’t plan to use it anymore. If you have an old credit card that you don’t use very often or at all, you might consider keeping it as well, especially if it’s in good standing and you aren’t paying an annual fee on it. That’s because your old cards are helping you project a long, steady history of paying your bills in full and on time.
Step 6: Limit the number of credit inquiries you make.
As mentioned previously, applying for various types of credit counts as a “hard hit” credit inquiry, so you want to limit these, especially in the months leading up to your mortgage application. Try to avoid purchases that require loans, like cars or boats, and if you’re applying for credit in order to diversify or build up your credit history, make sure you do it long in advance of buying a house.
When you’re shopping for a mortgage, apply with only the lenders you’re serious about. If you’re applying at more than one lender, try to apply within a two-week time period, as these credit inquiries are typically lumped together and treated as one.
Instead of applying directly with the lenders, consider using a mortgage broker. A mortgage broker can shop for mortgages on your behalf and typically only pulls your credit report once.
Step 7: Diversify your credit.
Lenders like to see a mix of credit types, rather than just one or two. Having a wallet full of credit cards isn’t as favourable as having a couple credit cards, a line of credit, a student loan and a car loan.
Try to mix it up, but don’t go overboard. You want to show you can manage a variety of credit types, without breaking any of the other rules we’ve listed here, like frequency of credit inquiries.
Step 8: Build up at least 65% available credit.
We’ve discussed the available credit threshold that credit bureaus and lenders like to see. If you’re coming close to maxing out credit cards and lines of credit, it may be a good idea to increase the limit on low-limit cards (ex. From $1,000 to $4,000).
If you haven’t had many hard hits on your credit, you could also apply for another credit card or type, and of course you can (and should) pay off the amounts owing to help improve your available credit.
How long does it take to improve your credit score?
If you have a blemish on your credit score like a consumer proposal, depending on where you reside, it typically stays on your credit report for up to seven years. However, as time goes by it will have a smaller and smaller impact on your credit score.
If you have something relatively minor affecting your score, such as a late or missed payment, it’s important to be patient. It can take one or two years to improve your credit score. By exhibiting positive credit behavior consistently over time, you will gradually bring your credit into good standing.
How long does a bad debt stay on your credit score?
Credit bureaus are permitted to keep negative information about your credit score for a prescribed period of time, depending on the information type and your province of residence.
Typically, bad debt stays on your credit score and report for up to seven years. This includes missed payments, bounced cheques, accounts sent to collections, bankruptcies and consumer proposals. There are, however, exceptions to the rule. For example, if you pay off all debts included in a consumer proposal, then it may be removed from your credit score and report in three years.
Improving your credit score all starts with using credit responsibly. Although there are a lot of factors involved, paying off your credit card in full and on time will go a long way in maintaining and improving your score.
And a good credit score pays off. You’re more likely to have access to the best mortgage rates from prime lenders, to cut down the cost your mortgage and reduce the time it takes to pay it off.