Buying a home demands a reliable income, a fairly large down payment, and a decent credit score. Since improving a person's credit can take months or years, this may be the first place prospective home buyers want to start. Credit scores affect the types of loans people can get, as well as the interest rate. In turn, this alters how much borrowers can qualify to receive. This information shows how a buyer's credit score determines how they buy a home, and what they can do to improve it.
Credit Score Fundamentals
Credit scores range from 300-900, with higher scores indicating a better credit rating. Canada has two credit reporting bureaus, Equifax and TransUnion. These agencies generate reports based on the information they receive from a person's various creditors. The algorithms they use to calculate a credit score are similar, but the scores will often vary at least a little. There are five different areas that make up a person's credit score:
- how much available credit they use
- credit types, such as credit cards or a mortgage
- the age of their oldest account
- new applications for credit
- payment history
Certain aspects may weigh more heavily than others. A person with a longer and more reliable credit history may notice that their score fluctuates less with recent changes than it could for someone just getting started.
Getting a Mortgage
Most lenders have a minimum credit score that an applicant must reach in order to qualify for a mortgage. This number depends on the kinds of mortgages the lender offers. Although borrowers often worry that they must have the best credit in order to get a mortgage, many lenders accept a fairly wide range of credit scores. Some will accept applications from people with a credit score of 600 or higher, depending on the loan amount.
For interested Beacon Hill home buyers who meet the minimum requirements, the credit score also affects the mortgage terms they might receive. People with lower credit scores may be limited to a lower loan amount. Lenders may require a larger down payment or a higher income to support a higher interest rate. Conversely, people with the best credit scores may receive offers with lower down payments and less-stringent requirements.
Mortgage Interest Rates
One of the most noticeable ways credit scores affect the mortgage is in the interest rate. Lower scores indicate a higher risk for lenders, who tend to charge a higher rate as a result. The interest rate affects the size of the monthly payment. As such, someone with a higher credit score might qualify for a loan that costs hundreds of dollars less than a buyer with a lower rating, even for the same amount of money.
Home Buying Power
The interest rate home buyers can get with their credit scores also determines how much they can qualify for in a home. Generally, lenders limit the percentage that the monthly payment can take up of a person's pay cheque. Borrowers must keep the gross debt service ratio under 35 percent of their gross monthly income. This ratio includes:
- half of the condominium fees, if applicable
Since mortgage interest represents such a large part of this aspect, a slight increase in interest rate might dramatically lower the amount that a person can qualify to receive. Higher interest rates may make it more difficult or impossible for buyers to purchase a home in areas with more expensive real estate.
Improving Credit Scores
Since buying a home is such a big decision for most people, one of the best things they can do is to look at their credit reports and scores at least a few months before applying for a mortgage. Each bureau allows people to apply for a free copy of their credit report once a year. Buyers should read the report carefully and identify any errors. Contacting the agency with evidence to support the correct information will help to remove it. People with lower credit scores may want to wait and work on eliminating debt or making timely payments to increase their scores. The result may provide better options for them when they are ready to buy a home.
When people check their credit scores, the number they see could affect the kind of mortgage they can get. Understanding how credit scores relate to buying a home, in the initial qualification and the maximum amount of the loan, helps people to plan for their financial future.