" If you want to have more credit, you need to know how credit scoring works.  "

All about credit scores and how they affect your mortgage

What is a credit score?

Credit Scoring, among others things, is a measure of how likely an individual will pay off debts. It tries to determine how much of a credit risk a consumer is to the lenders. A higher score signifies less chance for a person to default on his or her loan, and that the consumer the less "risky".

The scores can range between 300 and 900 and constantly change as new information is added to your file and old ones are deleted. Therefore, it can increase or decrease over time depending largely on how you manage your finances, particularly when it comes to paying your bills. The good thing about this is that if you have a bad score, you don't have to be stuck with it forever. There's a lot you can do to improve your scores and be deemed more credit-worthy by the lenders to get lower rates. On the other hand, if you have a good score, you are advised to keep monitorting it to keep it that way, or even improve it further. (Note: Pulling your own report does not hurt your score as long as you order from the bureau yourself.) It is easier to lose scores than it is to gain them back, especially if you have a track record of good scores in the past.

There are three major credit bureaus: the Equifax, the Experian, and the Trans Union. Each of them may have a credit report file on you. Each of them may also have different information on their reports about you. And each of them has their own credit score based on their information. That means that you could have 3 credit reports and 3 credit scores. Equifax calls their score called Beacon, TransUnion refers to theirs as Fico or Empirica, and Experian uses Experian/Fair Isaac Risk Model. Depending on what information is being reported by which bureau, your score could vary drastically from bureau to bureau. The most commonly used by Canadian mortgage lenders is the Equifax, but some may require the other scores as well or get an average on a combination.

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How does your credit score influence your mortgage?

Because credit is a promise to pay back loans, credit scores determine to a large extent whether or not you will get approved for a loan and how much interest you will pay once you get approved. In general, the higher your credit score is, the better the chances for mortgage approval at a lower rate. Although mortgage lenders also look at other factors like income stability, employment history, total monthly debt obligations, and value of the property dealt with, credit scores still play a large part on what kind of mortgage you get and whether or not you can get approved for one.

High credit scores allow some people to buy a home with little or no cash, and to have smaller monthly mortgage payments. Having good credit is therefore very important for anybody's financial planning and future. It is one of the key factors to the "good life."

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What is considered a good score?

Mortgage lenders usually have different cut offs as well as terms and rates they offer depending on your score. A good score is therefore hard to to define, but as a rule, the higher your score, the better it is for lenders to give a lower rate. Generally speaking, most lenders who offer lower rates (prime lenders) consider scores above 620 good.

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What does the report show and what constitutes a credit score?

Aside from identifying and verifying your personal information such as name, current and previous addresses, Social Insurance Number (SIN) number and employment history, your report shows inquiries made on your credit history, as well as your credit accounts, referred to as "trade lines" or loan accounts you have opened such as car loans, student loans or credit cards. It shows balances on those trade lines, your payment history on them, when you opened them and how long ago was your last activity with them. Public records such as collections, bankruptcies, foreclosures, wage garnishments, judgements, lawsuits and tax liens are also indicated on your credit report and can adversely affect it. Because of this, it is important to monitor your credit history in case none of them are actually yours and any of them shouldn't show up in your report.

It is important to note that some information should get purged from your report after a period of time. Positive information may stay indefinitely, but negative ones may not. Inquiries should get deleted after two (2) years. Late payments, foreclosures, and collections are required by law to be removed after seven (7) years. Bankruptcies should show up for maximum of ten (10) years.

There are five (5) main factors that constitute or affect your credit score, The following lists them in order of importance and how much approximate weight (in percentage) they carry in influencing your score:

  1. payment history - 35% - whether you pay on time. If you have paid late, how long has it been since you've been late, how often have you been late, how many accounts have you been late on and how long did it took you to pay for any of them. The more times you have been late and the longer it took you to pay on more accounts, the more points get taken out of your score. However, the more time has passed since the last time you were late in paying your bill, the less it affects the score negatively.
  2. amounts owed - 30% - bases calculation on how much of your credit limit on each of your account is being used. Maximizing your use of credit to it's limit affects your score negatively. We usually recommend our clients not to use more than 70% of their credit limit for each of their credit account. However, it also depends what your credit score is. The higher your score, the lower the percentage of your credit limits you should use to maintain, if not improve, your score. Also, the more you pay down your balance on installment loans such as mortgages or auto loans, the better your score can get.
  3. length of credit history - 15% - this considers the age of your oldest account or trade line reported in your bureau, as well as the average age of all your accounts.
  4. new credit - 10% - Applying for lots of credit in a short period of time can adversely affect your credit due to the number of "inquiries" generated, especially if you do not have a long history.
  5. types of credit used - 10% - a combination of revolving debts (credit cards) and installment loans (mortgage, car loan, etc.), gives the best result for higher scores. Bank credit cards are better for your score than department-store-issued cards.

Understanding and managing these components are critical to your current and future credit rating.

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Why are credit scores important?

Credit scores are now being used in many more places than just the mortgage approval department. Credit card companies, banks, and even insurance companies accept or reject applications based on credit scores. And that is why it is so important that you make sure yours is as high as it can be.

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How do you obtain a copy of your most recent credit history?

Pulling your own credit report does not hurt your score as long as you order from the bureau yourself. In order to know if you need to re-establish, improve or correct mistakes on your credit rating, you need to obtain a copy of your credit report. Try to obtain the one for Equifax since, as mentioned above, most mortgage brokers and lenders use Equifax. You may contact the Equifax National Customer Care Centre at 1-800-465-7166. For Trans Union, you may call 1-866-525-0265. Most of the credit reports must be purchased online through a reputable source, but you are entitled to get one for free on your own once every 12 months upon verification of your identity. (To request your free Equifax report, download the Equifax Report Request Form and send to the contact information found below the page after filling it up with your information.) However, scores are not free. Canadians may order Equifax scores from Equifax Canada and Trans Union scores from the Trans Union website.

After ordering your credit report, verify your identifying information such as name, Social Insurance Number, birth date, and address(es) you lived in. Scan the account sections and make sure there are no accounts, delinquencies, late payments, charges and negative entries that aren't yours. Any old negative files that should have been deleted after a period of time (10 years for bankruptcy, 7 years for collections, etc., accounts showing as unpaid even if paid off) should not be there. Hard inquiries you didn't authorize or those that should have been deleted for being more than 2 years old should not exist in your report. Watch out for any mistakes and report them immediately as they may indicate your file might have been mixed up with another person's, or worse, an occurrence of identity theft.

It is highly recommended to subscribe to a service that notifies you of any change made in your credit report. This not only makes you aware of substantial decrease, but it also helps you get on top of situations where mistakes are made or loans posted that are not yours. For this type of reporting, check out www.mycreditalert.ca .

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How do you build up credit history? Where do you start if you do not have any credit rating?

One of the importants facts you should know is that you need to have and use credit to build up credit and have a score. Having said that, at least one account needs to have been opened for six (6) months, and updated during that timeframe, in order to create a score. Account can be types of loans that are reported on your credit bureau such as credit cards, car loans, Lines of Credit, student loans, etc. Most mortgage lenders will consider applicants who have at least 2 accounts on their files, established for at least two years.

However, beware that you do not sign up with credit card companies that do not report your "true" credit limit as the credit bureau will tend to use the highest balance charged on that card as the limit, thereby possibly artificially inflating your credit utilization and hurting your score.

Here are three of our highly recommended credit cards or loans for you to sign up for and start building credit:

  • Home Trust Secured Visa - you will need to pay a security deposit in order to be eligible for approval. Your credit limit will be set at the amount of this deposit. To open one, fill out the Home Trust Secured Visa Application Form. All applications must be accompanied with a $1000 minimum deposit and copies of 2 pieces of Government issued ID. Mail completed application and your security deposit to: Home Trust Company, 145 King Street West, Suite 2300, Toronto ON M5H 1J8
  • People's Trust Secured Mastercard - requires a security deposit of at least $500. Fill up the People's Trust Mastercard Credit Card Application, print it out, sign and mail with your security deposit check to: Peoples Trust, P.O. Box # 48235, 595 Burrard St. Vancouver, BC, V7X 1A1.
  • Apply for an unsecured loan of about $2000 with a reputable financial institution like Citifinancial - this is a great way to establish credit for those who do not have money to put down for deposit on secured credit cards.
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What can you do to improve your credit score?

It is important to be knowledgeable on the factors that affect your credit score. Should there be issues with your report, this enables you to take simple steps to clean up your credit. Improving your credit score is the same as improving your credit. Here are several ways you can improve your credit score in a short amount of time:

  • Pay your bills and debts on time - Late payments, judgements and charge-offs have negative impacts on your credit rating. If you cannot pay off your bills, try to pay more than the minimum amount required on due date.
  • Pay down your debts and credit card balances - Keep your balances much lower than your total credit limit. Using 70% or more of your total credit limit on each account can be problematic. The higher your score, the lower the percentage of your credit limits you should use to maintain, if not improve, your score. In fact, one of the of the fastest ways to boost your score is to pay down your accounts prioritizing the one that has a balance closest to its credit limit (then to pay off the next one that is the same, and on and on until the last account in the priority list), in order to bring down your credit utilization to a more desirable level. Pay down your installment debts as well to keep your utilization low. The point is to reduce what you owe and not to shift balances between credit card accounts.
  • Avoid opening too many new accounts: Opening more new lines of credit or credit card accounts rapidly can make you look risky to a lender. Also, new accounts will lower your average account age, which will have a larger effect on your score if you don't have a lot of other credit information. Don't open a lot of new accounts just to increase your available credit or to transfer balances from older, higher-interest credit cards. Even if you save money on interests, the negative impact on your score might not be worth the benefits you're losing from a better credit score (e.g. lower interest mortgage).
  • Avoid more inquiries on your credit by not applying for more loans or credit cards than necessary - Each hard inquiry (i.e. inquiry you specifically authorize) lowers your score. Beyond the 10th inquiry within a 6 month period, there is no further negative impact in your score. Another common situation that trigger inquiries is shopping for mortgage rates with different lenders, with each pulling out a credit file on you. The best way is to get a reputable mortgage broker like Canada Mortgage Hub to do only one credit check and letting them shop your deal with different lenders. Another source that trigger inquiries is when shopping for new cars. Car dealers usually do a credit check even with test drives.
  • Carry small balances on multiple cards. Consolidating loans should be viewed with much caution. If you are refinancing your mortgage to pay off your credit card loans and reduce their balances, it is generally okay. However, having several cards with small balances looks more favorably than having a huge consolidated loan on one credit card account or line of credit, and making the balance exceed 70% of its credit limit. In this case, if you have already consolidated, it is advisable to not make matters worse by opening another new account to move some of the balance.
  • Have any incorrect information on your credit reports removed - See section on "Reporting Mistakes on or Updating Your Credit History." Should there be any negative information you absolutely cannot remove, the best way is just to let time go by. The older it gets, the less impact it will have.
  • Lower your payments on fixed payment loans like your house or car by refinancing to a lower rate and/or better terms.
  • Be careful about closing any existing credit card accounts or other revolving accounts as it may actually hurt your score, especially if they have been established for a long time.
  • Carry an assortment of loans: The last 10% of your score is decided by diversification. Maintaining only one type of credit (i.e., credit cards) tends to make you look riskier than someone who has managed both credit cards and instalment loans responsibly.
  • If you do not have any credit, start applying for one now in order to accumulate the number of months or years you have in your credit history. The longer the time since a particular credit line was established, the more favourable it is for your rating and the way lenders look at your history. However, beware that you do not sign up with credit card companies that do not report your "true" credit limit as the credit bureau will tend to use the highest balance charged on that card as the limit, thereby possibly artificially inflating your credit utilization and hurting your score.
  • If you have collections or long-standing debts you just paid off, keep all your receipts and records of all correspondence or paperwork between you and the creditor/lender. This makes sure you have proof to show the credit bureau, and speeds up the process in case you need your file updated.
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What do you need to know about Orderly Payment of Debts (OPD) and filing for bankruptcy?

Credit counselling is usually recommended before filing for bankruptcy. It is important to consider other options first before deciding to file because once you declare bankruptcy, it stays in your credit history file for 7 years. Bankruptcy is not a solution for everyone although it has certain advantages over having an OPD (which will be discussed a little later in this section). However, if you are suffering mentally, physically or emotionally from stress because of too much debt load that will take a long time to pay, it might be a good option. Again, we advise clients in such situations to first seek good credit counselling.

Orderly Payment of Debts or OPD, allows you to pay your creditors back in full over an extended period of time. What most people do not know though, is that having an OPD on your credit file is considered more negative as lenders tend to view borrowers with OPD's as more "risky" than those who declared bankruptcy. Reestablishing credit takes a longer time as well. With a bankruptcy issue, it can take only as little as 9 months before you may get discharged. Afterwhich, you may begin rebuilding your credit by obtaining secured credit cards and/or an unsecured loan. After one year of reestablished credit, you may be able to qualify for a mortgage. On the other hand, an OPD won't allow you to rebuild credit until 2 years after you have paid off your debt. The period of time to fully pay your creditors could take anywhere from 3 to 7 years. Prime lenders offering low rates would usually also have you wait 6 years from the start of your OPD file before considering approving you for a mortgage.

The bottom line is, purchasing a home, even after bankruptcy, is possible as long as you have re-established your credit history for at least one year. This means that you must have two, preferably three, loans or credit cards, with a minimum $2500 credit limit one year from the time you filed for bankruptcy. Make sure you also keep all documents related to the discharge of your bankruptcy and have the credit bureau update your file. The documents will be useful as proof to lenders you have been discharged should it take a while for your credit history to be updated.

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How do you update and report mistakes in your credit bureau?

In order to update or report mistakes on your Equifax credit report, call up 1-800-465-7166 to speak to a real person who can also give info as to how to "fix" your report. To send letters and receipts of paid debts for updating your credit bureau, you may fax a Consumer Credit Report Update Form found at www.econsumer.equifax.ca/ca/view/investigation/investigation.jsp to fax number 1-514-355-8502 or mail it by registered mail to:

Equifax Canada Inc.
Consumer Relations Department
Box 190 Jean Talon Station
Montreal, Quebec H1S 2Z2

Once Equifax receives your letter, they will start the dispute resolution process. By law, they are required to investigate any reported mistakes and get back to whoever reported it within 30 days. They will review the information you sent and if this does not resolve the problem, they will contact the submitter of the disputed information to review the details. The submitter will investigate and report to Equifax their conclusions. Equifax may then make the changes to your credit file unless the disputed information is correct. You will receive a revised credit report if changes are made. The whole process can take up to 60 days or longer to complete.


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