Want to buy a home? You’ll probably need a mortgage, which requires you to meet even the minimum credit score threshold. But to qualify for key mortgage products at the best rates, you’ll need an excellent credit score.
A good credit score in Canada can make it significantly easier to get approved for low-interest loans, get better access to quick credit, and opportunities for higher credit limits (for home buyers, that means a bigger mortgage loan).
The key, then, is to understand how your credit score impacts your mortgage application and rates and how you can improve a less-than-desirable credit score, both over-time as well as quickly.
What is a credit score? What is a credit report?
In the simplest terms, your credit score is a numbered ranking. The number tells creditors, such as banks, credit card companies and mortgage lenders, whether or not to approve you for a loan or charge account. It also helps lenders to determine what type of loan terms to offer you. Credit scores range from 300 to 900 with higher numbers considered better; those with higher scores get better loan and mortgage rates, better loan terms and greater access to credit.
Your credit score is based on specific information found in your credit report. Your credit score is based on your credit history which is captured in full by your credit report. Your credit report is used by lenders and investors to determine the likelihood that you will repay your debts. Essentially, a credit report is an itemized list of all of your credit accounts and, essentially, is a summary of how well you pay your financial obligations.
Lenders also report back to the credit reporting agencies, known as credit bureaus, about your activity. Lenders systematically provide details on whether or not you make payments on-time, how much credit you have available and how much of that credit is used and how long each account has been open.
Since credit reports are being continually updated, credit scores can change quite frequently based on the information reported back to the bureaus. This means how much you owe, how much you put towards paying your debts, as well as the number of credit accounts you hold and how long you’ve held these accounts, can all impact your credit report and your credit score.
In a credit report, you’ll find detailed information about any credit — loan or charge account — you currently have access to, the amount of debt you owe on that account, as well as how well you stick to your agreement to make payments on time.
Can I have 2 different credit scores?
While most people refer to their credit score as a singular number, turns out that each credit bureau in North America has dozens of algorithms that are used to calculate a credit score. For every credit scoring model that’s been developed, you have at least one credit score. This means that each person has multiple credit scores.
This can explain why one lender will give you more favourable loan terms than another lender. Depending on the credit bureau a lender uses to access your credit report, and examine your credit score, the numbers may differ slightly — and this could be the difference between a decent score and a good score, which dictates how good of a mortgage you can get, at this point in time.
“Credit scores are like salad dressing,” explains Julie Kuzmic, director of consumer advocacy for Equifax Canada, one of two credit agencies that provide credit bureau and information reports for lenders and account providers. “There are a number of different brands offering their own variations of salad dressing. Each may have their own recipe, but all are offering Caesar-style dressing. The same is true for credit scores both in the U.S. and Canada.”
Kuzmic adds, “while we often speak of a singular credit score, in reality, each person has a number of different scores. As a result, it’s not unusual to have variation among those scores, sometimes significant variation — with differences of up to 100 points between score results, depending on the algorithm used by the lender or account holder and supplied by the credit agency.”
Why such a big difference? Kuzmic explains: “The different algorithms and models were created and adapted over time to reflect consumer behaviour.”
For example, 10 years ago, mortgage and telecommunication accounts were not included in account records. Today, these accounts are considered an excellent resource to track and monitor a person’s credit history.
Still, no matter what score is used, almost all credit scoring algorithm models look for a way to predict how likely you are to pay your bills on time.
But this isn’t the only factor lenders examine when considering whether or not to extend a loan or give you a mortgage. Lenders also consider a number of other factors outside of your credit report when determining your eligibility for financing, such as income, your length of employment, your current assets, as well as the reasons as to why you’re applying for credit.
Where to find your credit score (a primer on credit reports)
There are only two major credit bureaus where you can access your credit reports: TransUnion Canada and Equifax Canada.
Although credit reports don’t generally contain your credit score, you’ll be able to learn invaluable insight about your credit history, as well as being able to check for any errors that may be present.
According to the Federal Trade Commission, an estimated 1 in 5 American consumers have errors in their credit reports. Which is exactly why it’s important to check your credit report regularly to make sure nothing is affecting your score when it shouldn’t be.
“There are horror stories of people who go for a mortgage pre-approval only to find a mistake or a forgotten credit account on their file that has badly damaged their credit score,” says Kuzmic. “That’s an awful time to discover a problem that needs to be fixed.”
To see your credit score, you can either:
- Pay the credit agencies a fee, typically between $10 and $50, depending on the report you purchase;
- Go through an external agency, such as your credit card provider, your financial institution, or financial tracking app. Quite often, these institutions offer free access to your credit report and your credit score.
- Sign up for a free report or pay a third-party company to access your credit score — just be careful. While most third-party companies are legit, there are plenty of scams. Be sure to check the credentials of the company before providing personal information.
For instance, there are ads that promise to remove collections from your credit file, for a low fee of $200. “Don’t fall for the magic pill solution,” warns Kuzmic. “It’s fake.”
The only time a credit agency is allowed to remove an item from your file is when it’s a legitimate error — and then, that service is done for free.
Remember, no matter what you are promised, no one can magically make your credit score go up 100 points overnight.
How is your credit score calculated?
Credit scores are calculated using proprietary algorithms created by credit bureaus. In Canada, both credit agencies (Equifax and TransUnion) have multiple scoring algorithms. Lenders and account providers will typically only use one algorithm when making credit and loan decisions. Since each algorithm will vary in what types of accounts and what weightings are used, the score version can differ, sometimes dramatically.
Regardless of what calculation method is used, there are five main factors that contribute to the calculation of your credit score:
- Your payment history (35%)
- The amount of debt you hold (30%)
- The length of your credit history (15%)
- The number and type of new credit applications (10%)
- Your credit mix (10%)
Your payment history is the single most important factor when it comes to calculating your score. That’s because, above all else, lenders want to know how likely you are to pay them back. Your payment history reflects all of your previous debt payments and gives lenders a better idea as to whether or not you consistently pay back your debts (which helps determine if you’re a good candidate for financing).
For this reason, it’s absolutely vital to pay your loans, on time. Even if you can only make the minimum payment.
Most credit score algorithms only look at the last 12 months of credit history, while some go back as far as three years. But late payments, defaults and bankruptcies can stay on your file for six to seven years. That means for at least half a decade, your credit history and your score could be impacted by past consumer behaviour.
“The good news is that the further in the past negative behaviour is, the less power it has to impact your score,” says Kuzmic. “That’s because almost all algorithms weigh heavily on recency.”
While some older credit score algorithms won’t include mortgage payments, most newer scores will, as well as every other type of loan and credit, including student loans, car loans, credit cards, lines of credit, and even personal loans are included.
The next factor is how much current debt you hold. The amount of debt you have access to versus the amount of debt you have used is known as credit utilization. The more debt you use out of what is available to you, the higher your debt utilization and the worse your score will be in this area.
The key is to have access to lots of credit, but not use this credit.
It’s also why many financial planners will advise against closing lines of credit or old credit card accounts. As long as these accounts aren’t costing you out of pocket fees, it’s a good idea to keep these credit lines open as long as you don’t max out the credit you have access to.
Turns out 15% of your credit score is based on the length or age of your credit accounts.
The longer your history of borrowing and paying the debt back, the better your score is on the ‘length of credit’ factor. For that reason, it’s a great idea to start building your credit as soon as you are legally allowed. For most, that means getting a prepaid credit card while at university. Even if you are late at starting to build this history, the key is to start and to maintain a solid credit record.
Next, is whether or not your credit accounts are new or not. New credit, or multiple recent applications for numerous loans or charge accounts, reflects poorly on your credit report. Known as “credit shopping,” it can be a signal to lenders that you are struggling with finances or that you could struggle with finances, as the more credit someone has access to, the harder it can become to keep up with the payments.
Each time you apply for any type of credit, the lender will check your credit report, the lender will check your credit report. This check is known as a ‘hard check’ — an official inquiry by a financial institution, lender, credit card issuer or account owner into your credit history.
Each hard check (also known as a hard inquiry, hard pull or hard hit) will lower your credit score by a few points (anywhere from two to 10 points). In most cases, one hard inquiry is unlikely to play a huge role in whether or not you get approved for a new mortgage or loan, but a series of hard checks can hurt your chances. It’s why mortgage brokers strongly advise you not to apply for new credit cards, store accounts or personal loans shortly before shopping for a mortgage.
There is one exception: Mortgage lenders and lenders for car financing know that you will probably shop around to get a good rate. For that reason, a series of hard checks in a short period of time for the same type of loan — a mortgage or auto financing — will be registered in your credit history one hard check. The key, however, is to make all these loan inquiries within a relatively short period of time.
“If a lender sees six mortgage-related hard-inquiries in a two-week period, they know the person doesn’t intend to buy six houses,” says Kuzmic. “The person is shopping for the best mortgage product.” As a result, these six inquiries will actually get grouped into one ‘hard hit’ against your credit profile.
“Just be mindful of how quickly you shop for rates,” says Kuzmic. “Different score versions have different timelines, with some lenders only grouping similar hits in a 15 day period and others grouping similar hits within a 45 day period.” To be safe, Kuzmic suggests shopping for mortgages (and car loans) within a two-week period.
On the other hand, a soft inquiry is when a person or company checks your credit as part of a background check. For example, when a credit card issuer checks your credit to see if you qualify for the card or specific offers, or when an employer runs an inquiry before hiring you. Soft inquiries do not affect your credit score.
The final factor that impacts your credit score is the type of credit used. Lenders want to see a variety of credit accounts on your file. Reliance on any one type could indicate problems. For instance, if you have many payment plan loans or deferred interest credit accounts, this could be an indication that you struggle to save up for purchases; if you have a few consolidation loans, it could mean you constantly run into difficulties with paying your debts (and need to find help). Plus, certain types of credit are more favourable. For instance, lenders know that you can get into more difficulties with a revolving line of credit — like a Home Equity loan or a credit card — than with an instalment loan.
The good news is the longer and more varied your credit history profile, the less this factor weighs on your score. It really only matters to people just starting to build their credit history, explains Kuzmic.
What is a good credit score?
Essentially, a higher credit score is always going to be better than a lower credit score.
In Canada, credit ratings are broken down into five categories:
- Poor – 559 and under.
- Fair – 560 to 659
- Good – 660 to 724
- Very Good – 725 to 759
- Excellent – 760 and over
(In America, these ranges vary slightly with excellent scores ranging between 800 and 850; very good between 740 and 799; good scores between 670 and 739 and fair scores between 580 and 669).
While knowing your credit score is an excellent place to start when preparing to apply for a mortgage or other type of loan, be prepared for the fact that this score frequently changes. Also, don’t be surprised if your score differs from one lender to another. (See How is your credit score calculated.)
Impact of your credit score on your financial life
In simple terms, your credit score can affect your life in a number of ways.
Having a poor credit score can significantly limit your options when shopping for a new home or for financing. Generally, if you have a lower credit score, you might have a hard time getting approved for low-interest financing.
In Canada, the minimum credit score required in order to be approved for a mortgage is pinned at 640. More accurately, however, any score between 620 and 680, is sufficient enough for a lender to approve a mortgage (all things being equal and assuming all other factors are met).
“A score of 630 puts the borrower in a subprime market,” says Kuzmic — a market where rates and terms are less favourable for the borrower.
Remember, credit scores alone do not determine whether or not your loan request will be approved. This number is only one tool used by a lender, which is generated from your credit history report.
Even if you’re not looking for a mortgage or financing, having poor credit can even make it harder to find a place to rent, in certain situations it can impact your ability to get a job or even get a charge account or credit card.
To be approved for mortgages, loans and credit cards, you have to show that you’re a seasoned, responsible borrower who is likely to repay on time.
Tips for improving your credit score
But what if you don’t have a history as a seasoned, responsible investor? What if you’re just beginning to build your credit history? Or you’ve had a few debt hiccups along the way? Can you improve your credit score (and how to improve your credit score)?
The best things you can do to improve your credit score are to manage your money wisely, using a realistic spending plan, and to deal with your debts.
Sounds tedious, but it’s true.
“Companies, agencies or counsellors can’t quickly and easily ‘fix’ your credit score or credit history,” explains Kuzmic. “Some companies say they can solve your debt problems quickly, or promise to boost your credit scores, but this isn’t possible. What’s worse, is that many of the actions taken by these firms or people are actions that people can do for themselves — for free.”
Kuzmic advises anyone looking to repair their credit history to stay away from anyone who promises a quick fix (particularly if they want payment for this service). If you really require guidance, consider talking to a legitimate credit counselling agency. You can start your search for one through the Financial Consumer Agency of Canada.
The key takeaway is that there are no quick-fixes for factual but negative information on your credit report. The only real fix is to live within your means, consistently pay your debts on time and repeat this process over and over.
But what one person may need to do to help build their credit score, may be totally different than what another person must do.
Each agency will create algorithms based on a lender’s needs. This means that the credit algorithm used could weigh one factor, such as credit utilization, higher than, say, another credit algorithm. The result is that two people could end up with the same credit score, but using slightly different algorithms. As a result, these same two people could take the same action, say to improve their score, with differing results.
For example, say Person A went to a lender that heavily weighted new accounts and Person B went to a lender that heavily weighted credit utilization. If both borrowers then applied for a new credit card, they could end up with different results. Person A’s credit score could drop, since a credit card application is a request to open a new account and results in a hard hit that’s weighed significantly by their lender. Person B, on the other hand, may see an increase in their credit score, as the approval of a new card would add to the total amount of credit the person had access to, thereby decreasing their credit utilization ratio.
“A good strategy for one person, isn’t always a good strategy for another person,” says Kuzmic.
Still, we all need a place to start, so here are six tips to help improve your credit score or your chances of getting a mortgage:
1. Monitor your credit report
One easy way to improve your credit score is to find and remove false or negative information in your credit history.
As Kuzmic explains, late or missed payments can stay on your credit report for as long as six years. While removing negative information from your credit report is really hard. However, removing negative information that isn’t accurate is a great way to boost your credit score.
To dispute negative entries, you must first request and examine your own credit report (don’t worry, your inquiry is registered as a soft hit). If you find an error, fill out the credit bureaus form for corrections (found on online).
Another option is to request from the creditor a removal of the entry from your credit report. This request can be made over the phone, or you can write a letter with a formal request. If you’ve already paid the debt, but just want the entry removed from your record, consider writing a goodwill letter, instead.
2. Increase the average length of your credit history
Quite often the knee-jerk reaction to fixing your credit score is cut up all your cards and close all your credit accounts. Don’t.
Your credit score is based on how well you handle credit accounts in the past. If you don’t have accounts, you don’t have credit history and this will hurt your credit score. For this reason, it’s absolutely vital to have open, active credit accounts in good standing. It’s also a really good idea to keep old accounts — even accounts you don’t use — open and “ready” to use. That’s because the more accounts you have that go back over a longer period of time, the longer your ‘average’ credit history is and the better your credit score. It’s known as ‘credit age’ and it impacts your credit score because your score factors both the age of your oldest account and the average age of all your accounts. By keeping old accounts active you have a greater chance of developing a mature credit age, and this helps increase your overall credit score.
3. Use credit wisely
But just because you keep those old accounts open, doesn’t mean you need to use the account. This is particularly important when it comes to showing how well you can pay your bills, on time. Since the biggest factor to influence your score is your payment history, you need to be wise about how and when you use your credit. The more timely your payments, the more your credit score will improve.
While it may go without saying, I’m going to say it: Don’t let your accounts wind up in collections. When lenders examine your credit report, debt collection accounts are considered a big deal. Remember, even small accounts, such as library or parking fines, has the potential of going to a debt collector, so deal with all debts in a timely manner.
4. Limit your new applications
Remember, each hard hit on your credit report lowers your score slightly. For that reason, only open new credit accounts sparingly.
There’s another reason to limit the number of new accounts: Each time you open a new account, it’s added to the pile of accounts used to calculate your ‘credit age’. If you have a large number of new accounts, this can dramatically lower your credit age, which can lower your credit score.
The key, then, is to only open accounts as you need them.
5. Use different types of credit
Adding ‘good’ accounts to your credit report will boost your credit score. This will mean different solutions for each person, but, in general, it means varying the type of credit used.
For instance, if you rely solely on credit cards, consider taking out a personal loan and then paying it back (on time and in full). On the other hand, if you’re relying on a personal or consolidated loan, consider judiciously using a credit card (even a secured credit card or a card aimed at those building their credit). The key is to vary the type of credit used, to show lenders that you can handle and you are responsible with various types of loans.
6. Shop around for a mortgage
This might seem like a common sense thing to do — who hasn’t been told to shop for the best rate, but shopping for a mortgage isn’t just about the lowest rate. By going to different lenders you are increasing your chances of finding a lender who uses a credit score that puts you in a more favourable position. This is why, quite often, a borrower can walk away from two different lenders with vastly different mortgage offers.
Quick tips for those in the mortgage pre-approval process
You’ve just gone for that mortgage pre-approval application and your broker told you that there is a possibility that your credit score is either too low to be approved, or low enough to impact your chances of getting a good rate. What can you do?
Thankfully, you have options. Here are eight tips that could help boost your credit score, now.
#1: Pay off past-due accounts
It should go without saying, but I’ll say it anyway: If you want to improve your credit score, pay your past-due accounts.
Since the biggest factor to impact your credit score is payment history, the biggest boost to your score will be up-to-date payments on all accounts.
This is particularly important if you are newer to building a credit history or your credit limits are still relatively small.
#2: Reduce high balances
Since credit utilization plays an important role in determining how likely you may be to default on paying your loans, a good way to increase the chances of being viewed as a good borrower is to reduce any high debt balances you may be carrying.
The simplest way to do this is to aggressively tackle a really high-balance loan amount or outstanding credit card balance. This will require you to pay down the amount, relatively quickly. Do this 30 to 60 days before making a formal application for a mortgage, and you have an excellent chance of applying for that mortgage with a higher credit score.
Another method of increasing your credit score by reducing high balances is to pay off revolving credit lines before the statement or due date. Almost all lenders will systematically report your payment history — notifying the credit bureaus that you successfully paid on the due date, how much was paid and how much is still owed. However, if you pay prior to the due date, not only will your lender report successful payment of the loan, but they’ll report a lesser amount owed, since the outstanding sum is now reduced, based on the early payment. This helps to reduce ‘high balances’ on your credit report, which can help raise your credit score.
#3: Stop favouring one credit card
Most people have a few credit cards or even lines of credit but tend to use only one form of credit. Perhaps, it’s a low-interest credit card or you like the reward options, but neglecting other credit cards or credit lines in favour of one doesn’t help when you’re trying to boost your credit score.
That’s because lenders like to see regular use — and repayment — of a variety of credit accounts. It shows lenders that you are a responsible consumer: Someone capable of borrowing, and paying back debt, on time.
If you’re in a situation where you need to boost your credit score even just a few points, a great way to do this is to use all your available credit fairly regularly. This can be as simple as a small charge against the credit once per month. By doing this, you ‘re-activate’ this credit account by updating the last-activity date (known as DLA), which allows this credit account to pull a bit more weight in establishing responsible use of multiple credit lines (and helps to increase the average credit age of your credit history). You’ll need at least a month before you apply for the mortgage loan, but do it and this should help add much-needed points to your score, relatively quickly.
#4: Focus on credit utilization
Want to add points? Consider how much credit you are using on each credit account. For instance, if your primary credit card is consistently maxed out, but your personal line of credit is rarely, if ever, touched, then you need to act fast.
For each account, try and keep your credit utilization — the amount of credit used compared to the amount available — to less than 50%.
For example, if you have a $10,000 limit on a credit card, and you consistently rack up monthly statements of $6,000 or more, then consider switching some payments to another credit card or a line of credit. By doing this you could drop your credit utilization for this primary card to under 30% and start to build a history with another credit account — which helps to boost your credit score.
#5: Ask for a higher credit limit
Another way to reduce credit utilization, and gain points on your score, is to ask for higher credit limits. If you call your credit card provider and ask for a higher limit than your credit limit increases, even if the balance owed stays the same. This changes your credit utilization ratio, which helps with your credit score. Just be sure to confirm with your provider that a limit increase can be accomplished without a hard inquiry against your credit profile; the last thing you want is to watch your credit score drop a few points due to a hard hit on your credit history.
#6: Don’t cancel old credit accounts
Because credit utilization and credit age are two important factors in establishing your credit score, it’s a good idea to avoid cancelling any credit accounts just before applying for a mortgage or loan. That’s because these old accounts may be helping to establish a longer average credit history — a factor that certainly helps to increase your credit score.
But what about cancelling cards you no longer use in order to save annual fees? While this can be a smart move (nobody should pay for access to credit they don’t use), the cancellation of this account can negatively impact your score. Instead, call the account manager and ask about your options. Quite often, there is a no-fee account option that you can select that would eliminate that annual fee, without ending your credit account and removing the account history.
#7: Make frequent payments
One quick way to add a few points to your credit score is to reduce balances owing. This means paying attention to statement dates and posting payments before due dates.
By making small, frequent payments — known as micropayments — throughout the month, you can keep your credit card balances down, which goes a long way to keep your credit utilization low. If you can keep your credit utilization low, rather than letting your owed-amount build-up by the payment date, then your credit score will benefit right away.
The best way to do this is to make frequent small payments (pay off a charge, as soon as you make it). Another option is to plan your payments; this means keeping track of statement dates and posting payments several days before this date. Then, when a credit agency gets the reports from your accounts on outstanding debts owed, the total amount is much lower than what you actually used, which reduces your overall credit utilization, which helps boost your credit score.
#8: Engage in a rapid rescoring
When you borrow from your credit accounts and make repayments, this information is tracked and recorded in a systematic way. That means that on a recurring basis, the lender will report when accounts are opened, closed, money is borrowed and repayments made. At best, this tracked information is updated once per month.
However, for quicker results, you could discuss ‘rapid rescoring’ with your lender.
Rapid rescoring of your credit score is a service that lenders can use to make quick updates to your credit reports. Instead of waiting for the regularly scheduled updates — which are done in batch reports — you or your lender will manually update the information.
For example, let’s assume you owe $8,000 on your credit card and it’s 28 days until the next batch update. Ask your lender if they can push the notification of your repayment to the credit bureaus. Instead of waiting 28 days for your credit report, and your credit score, to be updated with this repayment information, you may only wait a day or two.
If you are actively in the market for a mortgage or a consumer loan, this rapid rescoring strategy can help quickly improve your credit score — and this could make the difference in whether or not you qualify for the loan.
Why recent FICO changes don’t matter (to Canadians)
Recently, FICO announced the rollout of their new FICO 11 credit scoring model. The aim of the new FICO score model is to help lenders better identify risk and to help them reduce their default rates. The change garnered big headlines, with many American news agencies reporting that as many as 40 million consumers could expect to see a drop of about 20 points under the new FICO 11 model, due to a new scoring system that treats debt and missed payments more severely than before.
But Canadian consumers shouldn’t worry too much. First of all, there are no lenders or account providers in Canada that use FICO scoring. The two agencies that provide credit reports and scores in Canada are Equifax and TransUnion.
Plus, any change in an algorithm today, doesn’t mean industry-wide adoption anytime soon.
“Adding in the new account information or changing the algorithm is the mathematical equivalent to adding an egg into a cake that is already baked,” says Kuzmic. “It’s a huge project for a major bank [or lender or account provider] to change the credit score algorithm they’ve been using. They have to go line by line to check risk protocols. It’s not a plug and play option.”
The reality is it will take at least a year, if not longer, for lenders and account providers to transition to a new algorithm, if at all.
Bottom line on how to repair and improve your credit score
Although a poor credit score can have a negative impact on your life, it’s not a death sentence. And fortunately, there are many ways you can work at improving your credit score.
For starters, paying your bills on time will go a long way towards improving your score, since your payment history is one of the biggest contributing factors to your credit score. For best results, try and make more than just one monthly payment. And it’s also important to try and keep your credit usage to no more than about 30% of your available credit. The lower, the better.
You can do this in two ways: either by asking for a credit increase, which will lower the percentage of credit usage. Or, you can work towards paying down your balance, which will also achieve a lower usage.
Another way to quickly improve your credit score is to consolidate any existing debts that you might have. So if you have a high credit card balance and have been having difficulties paying it off, you might want to consider applying for a low-interest balance transfer credit card or if possible, a low-interest personal loan.