Saturday, February 9, 2019

Improving your credit score for a mortgage application


Twenty-five years ago when I applied for a mortgage on my first home purchase, I had no idea what my credit score was.  Even if I had wanted to know my score, there was no official way to find it out.  Now services like Borrowell and Credit Karma provide easy access to your credit report and show you a credit score that is similar to the Beacon score that is used for most mortgage applications.

To qualify for an insured mortgage, CMHC requires a minimum credit score of 600.  To qualify for a lender's special rates, you'll often need a score of at least 650.  Your score also can impact how much of a mortgage you can qualify for, with a score under 680 reducing the amount you can borrow.  CMHC's debt service guidelines state:
The standard threshold is a gross debt service (GDS) ratio of 35% and a total debt service (TDS) ratio of 42%. The maximum threshold is a GDS ratio of 39% and a TDS ratio of 44% (recommended minimum credit score of 680).

For most mortgage lenders, there is no benefit to improving your score beyond 700.  The only exception to that I'm aware of is TD, where their typical threshold for their FlexLine HELOC requires a score of 730.

When it comes to improving credit, one of the better guides I've found is published by the Financial Consumer Agency of Canada.  While the guide is a good place to start, there are a few important things it doesn't mention that can have a big impact on your credit score.

The easiest and quickest way for most people to improve their credit score is by optimizing utilization.  While most guides and blogs will recommend a maximum overall utilization of 30-35%, I think there is too little emphasis on the importance of utilization on each card.  I'll use an example of someone with two credit cards, one with a $3,000 limit, and another with a $7,000 limit.  Using the full $3,000 limit on the first card and $500 on the second will result in a much lower score than having $1,000 on the first card and $2,500 on the second.  In both cases the overall utilization is the same 35%, but when a card is at or very near the limit, your score will be significantly impacted.

If you are a financially-prudent person who never gets in debt, usually paying with cash or debit and saving your credit card for emergencies, you may be surprised to find you have a low credit score.  That's because your score is based primarily on how you've used the credit you have.  If you never used your credit in the past, it's harder to predict how you'll use it in the future.  So if you have a couple of credit cards, it's best to use them at least once before you apply for a mortgage.  Having a small balance (<10% of your limit) on your credit report is actually better for your score than a $0 balance.

I often read recommendations to build credit using secured credit cards.  I would only recommend a secured card for people that can't get approved for a Walmart or Canadian Tire Mastercard.  I've read lots of reports from people with scores below 600 that have been approved for them.  If your score is below 550, I'd first try applying for a monthly cellphone plan.  Even people with a score between 500 and 550 can often get approved for at least one line, and once that gets reported to the credit bureau for a couple months your score should go up enough to get approved for an unsecured credit card.

One last tip for people that don't already have an installment loan on their credit report is to apply for a small RRSP loan.  I recently tested this theory with Tangerine where I've had a chequing account for over a year.  I applied for a loan of under $500 and was approved without a hard hit to my credit bureau.  Within a month the installment loan showed up on my credit report.

I think it is more important to tweak your score today than it was in years past.  That's because mortgage underwriting has become more automated and involves less discretion than it used to.  If you know how to arrange your finances to optimize your score before you apply for a mortgage, then you can reduce the chances of being declined or having to persuade the lender to make an exception to their normal rules.