Everyone knows you need good credit to buy your first house, but how does credit work and how do you get it? Read on to get the run down on the 5 C’s of credit: Character, Capacity, Capital, Collateral, and Conditions.
Lenders want to know if you’re the type of person they want to lend to. They want to know if you’re going to repay your mortgage as agreed. In other words, they want to know if you have good character.
Unfortunately, your winning smile and character references aren’t going to be enough to prove your reliability. In this case, the mortgage lender is going to look into your credit history.
Your credit history is put together by any lenders or services providers you previously and currently work with. This includes things like your cell phone and utilities providers and any lenders you owe money to (like credit card companies or banks where you have a loan.) If you gave the provider your social insurance number when you signed up, chances are they’re sending in credit reports.
With your permission, the lender will access these reports to see if you’ve been paying your bills on time. The lender will also be able to view your credit score, a number between the range of 300 and 900.
You should also get a copy of your credit history for yourself. With these details in hand you will know better how to prepare yourself for your mortgage application.
Steps to get ahead
- Get your credit reports These are most commonly accessed through TransUnion and Equifax. Reviewing your credit reports will help you to know which accounts affect your credit, give you a chance to spot and report errors, and report fraud. If you discover a product or service in your name that you never signed up for, report it immediately.
- Get your credit scores Both Equifax and TransUnion calculate your credit score differently. Mortgage lenders will look at both scores but will probably only use your Equifax score. However, it is important that you have the details on both. Once you know where your credit score stands you’ll have a good idea how much work you may or may not have to do to get the mortgage you want.
- Get mortgage lender details Many lenders will group credit scores into tiers and offer each tier associated mortgage options. The better your tier the better your options. If it turns out that your credit score is just a few points away from the next best tier it may be worth it to take the time to improve your circumstances before applying for your mortgage.
Capacity is your ability to take on debt. This is calculated using your income and your existing debt. Your lender will want to know how long you have been with your current employer and how much money you make. They will look at your most recent tax return as well as a few recent pay stubs to determine your income.
The lender will also look at your existing debt and, using it and your income, calculate your Total Debt Service (TDS) ratio. This ratio is a total of all your monthly debt payments divided by your total monthly gross income. You don’t want this ratio to be more than 44%. Lenders use this number to determine how much additional debt you can take on.
Steps to get ahead
- Minimize a high TDS ratio If your TDS ratio is higher than you’d like (or too high to get a mortgage) start by bringing it down. This can be done by increasing your income or decreasing your debt.
- Put together some savings Lenders always like to see that you have some money set aside. In addition, having cash or liquid assets can offset a high TDS ratio.
- Look for a cheaper house If buying the house you had in mind is going to send your TDS ratio through the roof, and you don’t want to wait to improve it, consider buying a house with a smaller mortgage.
- Research the cost of homeownership Many new homeowners are unaware how many extra expenses come with a house. Read here to learn more about the additional costs you’ll need to plan for.
Capital includes any investments, savings, assets or properties you will own after the purchase of your home. Lenders want to know you’ll have something to fall back on if you lose your job or hit a financial rut in the road. Knowing you have a “cash cushion” will give them a sense of security that you’ll be able to continue paying your mortgage.
Steps to get ahead
- Talk to your lender Find out exactly what kind of capital they want you to have.
- Find your comfort zone It’s one thing for the lender to be at ease, it’s something else for you personally. Take a good look at your finances and determine for yourself how much of a “cash cushion” you need to have in order to feel comfortable.
Collateral is what you promise to give someone if you don’t give back what you borrowed. In the case of a mortgage, the collateral is usually the house itself.
If your down payment is at least 20% a home inspection will probably be done to make sure the property is sufficient collateral. If you put down any less an inspection isn’t likely, but you’ll have to pay CMHC insurance. The Canadian Mortgage and Housing Corporation provides the collateral to your lender should you fail to honour the mortgage agreement.
Step to get ahead
- Get the details Whether you go for a traditional mortgage, choose to use a down payment assistance program, or end up paying for CMHC insurance, find out what your lender’s collateral requirements are.
You can do a lot about the first 4 C’s we’ve covered, but you can’t do a thing about the last one: Conditions. This refers to things like supply and demand, the cost of living, and insurance rates. The only available action here is to do your research.
Steps to get ahead
- Start with a pre-approval This application is given to a lender who then responds with a quote for how much money they may be willing to lend you and the best interest rate available for your circumstances. You can technically submit an application to each lender on your own but each time someone reviews your credit your score will take a soft hit. Too many of those and you’ll start to see some damage. The best option is to instead work through a mortgage broker who will review your credit only once and submit your information to multiple lenders simultaneously.
- Consider other options Many new would-be homeowners only think of going to their current banker for a mortgage, but there are many options available. Consider other big banks, small banks, mortgage companies, and credit unions.
Once you’ve taken steps to get ahead in Character, Capacity, Capital, Collateral, and Conditions you’ll find you have the credit you need and the Confidence to buy your first home! For more information, or to get started, contact us today!