How credit rating impacts a property purchase
Published on July 7, 2023
Most people don’t know their own credit rating or understand exactly how it’s calculated. But the credit rating plays a critical role in our lives after adulthood. You need it to carry out most financial projects or get key services, and the credit rating is decisive when it comes time to apply for a mortgage.
Whether your credit rating is good, average or poor, find out what impact it has on a potential property purchase and what solutions are available to improve your score.
Contents:
- What is the credit rating?
- Credit rating and buying a home
- Improving your credit rating to buy a property
- Conditions to qualify for a mortgage
- The credit rating: A key role in buying
What is the credit rating?
Also known as the credit score or debt rating, this is a 3-digit number calculated using a mathematical formula and based on data from each person’s credit file. In Canada the credit rating is determined by two main private credit bureaus: Equifax and TransUnion. They gather information from creditors, and then store and share information about each individual’s credit rating.
The credit rating is used to measure solvency, or creditworthiness and is mainly based on:
- Bill payment history (35% of the credit rating)
- Account history (date of opening)
- Amount of credit available (credit use)
- Types of credit used (number and variety of creditors)
- Recent credit activity (new requests or applications)
Thus, the credit rating is changeable: an individual can gain points by acting responsibly or lose some through poor credit management. It’s positively or negatively impacted by the individual’s payment and lending habits. Paying bills late or getting close to your credit card limit can lower your credit rating. Paying bills on time, every time, can improve it.
The credit rating ranges from 300 to 900. Equifax explains that ratings of 660 to 724 are generally considered good, 725 to 759 as very good, and above that as excellent.
The credit rating’s role
The reason for the credit score is to determine a person’s ability to meet their financial commitments. Lenders, telecom companies, insurers, renters and government agencies use it to assess the level of risk in granting a loan. Therefore, having a poor credit rating can be an obstacle to getting credit or some services.
Knowing your credit rating
There are different ways of checking your credit rating. First of all, the customers of some banks, including Desjardins, can view their credit rating at any time through their online account. The rating is updated monthly.
Second, it’s possible to get your credit rating directly from Equifax or TransUnion. Ordering your credit file has no impact on your credit rating. It’s even recommended to check it often to get a clear view of your financial situation and to detect any potential fraud attempts.
An individual has several credit ratings, depending on the company calculating it. Therefore the credit rating that’s available for you to look at is for information purposes only.
Credit rating and buying a home
Buying a home often involves a mortgage loan. Few people have the funds to buy a property in cash. So the dream of being a homeowner generally involves borrowing from financial institutions or private lenders. There will be more or fewer options available to you depending on your credit rating.
Minimum credit score
There is no specific credit rating that gives access to a mortgage to buy a house. Each lender determines their minimum credit score for accepting a loan request.
Despite this, according to Equifax, anyone with a credit rating under 560 could have trouble being approved for credit.
Its impact on buying a home
The credit rating comes in when buying a property requires a first mortgage, a new loan or a renewal. It not only influences a person’s ability to get the mortgage but also the loan’s characteristics.
The higher your credit score, the more mortgage and interest rate options are available to you. Equifax considers that a score lower than 660 (the bottom limit of the “good” category) could close the door to some credit options. However, there is no “magic score” to access better mortgage conditions, terms or interest rates.
To sum up, if you’re buying a home, the credit score can impact your:
- Eligibility for a mortgage
- Loan conditions
You should know that the credit score is only one of the factors taken into account in determining an aspiring homeowner’s creditworthiness.
Benefits of a good credit rating when buying
Financial institutions look at a person’s credit record and use the credit score to decide whether or not to grant a loan, but they also use that information to determine the interest rate they will offer. In this way, people with a good credit rating are likely to benefit from a lower interest rate than those whose risk level is considered higher.
A better interest rate lets you:
- Save money on the amount of interest you pay for the mortgage
- Decrease the length (term) of the loan
- Get greater buying power to get your dream home
Options for buying a home with poor credit
A low credit rating doesn’t necessarily mean having to give up on the dream of buying a house. You simply have to explore other options.
First, this may seem obvious, but if you can pay off the whole amount of the sale, without borrowing, then the credit score no longer matters. It’s also possible to make a higher down payment. With a lower credit score, lenders will prefer a down payment of 20% minimum.
If you already own another piece of real estate, it is possible to benefit from the equity to finance your new purchasing project. This is known as mortgage refinancing. It involves using the difference between one property’s market value and the balance of the mortgage as the down payment on another property.
Another option is to get someone to cosign or guarantee your mortgage. The cosigner becomes a co-owner, while the guarantor becomes responsible if you miss any mortgage payments.
Finally, there are alternatives to explore if your credit rating doesn’t reach the minimum required by type A lenders (conventional, major lenders). You can then look into B lenders, also known as private lenders or higher-risk lenders. Mortgage brokers specialized in poor credit records can generally refer their clients to this type of lender. However, this solution is often expensive. In addition to a higher interest rate and a shorter term (often 1 year), it is sometimes necessary to pay a file opening fee and, often, a 20% down payment is required.
Improving your credit rating to buy a property
Knowing that the expenses involved in a mortgage from a B lender can be much higher, it’s often more advantageous to delay your buying plans to give yourself time to improve your credit rating. If you follow best credit practices to the letter, you may see the first improvements in a few months, and a real improvement after about 1 year.
Since credit bureaus and lending institutions do not reveal the formulas used to calculate their credit ratings, it’s not possible to know exactly how your actions will increase your score.
Here are strategies to improve your credit score by staying disciplined:
- Keep an eye on your payments
- Concentrate your payments on one or two credit cards, maximum
- Pay off your debts in full rather than the minimum payment if possible
- Activate a system of electronic warnings (for exceeding a transaction limit or when a payment date is approaching)
- Use automated payments for some bills (insurance, phone, Internet, loans, etc.)
- Increase your credit limit and use 30% to 35% of the limit (do not go over!)
- Keep unused accounts open to create a longer credit history
- Vary the types of credit you use (credit cards, credit line, car loan, etc.)
- Limit the number of credit requests you make (these are visible in your credit report)
- Demonstrate financial stability (stable address and job, and regular income)
- Check for potential mistakes and fraud in your credit report
Doing several of these at once will let you see results faster. And don’t hesitate to register for a credit improvement assistance program or ask a financial advisor or mortgage broker for advice on your personal situation.
Conditions to qualify for a mortgage
In addition to the minimum credit score, there are other factors involved in determining whether or not someone qualifies for a mortgage lender’s requirements for buying a home. This is especially true for people whose credit rating is slightly lower than average.
Here are a few examples:
- Amount of the loan
- Amortization period
- Type of real estate being considered for purchase
- Debt-to-income ratio
- Employment record
- Current debts (credit lines, credit cards, student loans, car loans, etc.)
- Result of a “stress test” that looks at an individual’s tolerance to fluctuations in the interest rate
In short, there are several other factors that enter into the decision of what type of mortgage will be given and by who.
Familiarize yourself with mortgage terminology!
The credit rating: A key role in buying
It’s undeniable that the credit score plays a front-line role when you’re planning to buy a home. It has a direct impact on the loan conditions you’ll be offered, as well as the rate, term and amount. What’s more, poor credit can close the door to conventional lenders.
That’s why it’s to your advantage to adopt sound financial habits and to keep your credit record clean. You can do this by paying your bills on time, respecting your credit limit, having a budget and building a contingency fund.
Don’t forget that it’s never too late to improve your financial situation and to take your credit in hand. You could see the benefits faster than you think!
Do you have real estate to sell? Our team is there to get you the visibility and support you need to sell broker-free and commission-free. Discover all our tools and services by scheduling a call with one of our advisors or watching our videos on the steps involved in selling.
