It takes credit to build credit – most of us have heard this at some point in our early years of adulthood. Some of us heard it when we got our first credit card; others when they went to apply for a loan of some type and realized they didn’t have a credit score. The crux is that while it takes credit to build credit, it also takes credit to destroy credit. So, what exactly is “credit” when it comes to finances, and how does your credit score affect your mortgage interest rate?
Credit is essentially a numbering system that gauges how likely you are to repay borrowed money. The higher your score, the ‘safer’ you seem to lenders, and the lower your score, the ‘riskier’ you are.
The first step to building your credit is to take out a credit card. Credit cards typically carry a high-interest rate and can be a bit of a risk if you use them too freely without considering that you have to pay it off afterwards. However, by having and using a credit card and then paying off your balance in part or in full each month, you show the lender that you are likely to repay your debts. This helps to increase your credit score. In addition to making payments on time, it is essential to keep balances low as this shows the lender that you aren’t spending more than you’re able to pay back.
Next, it is important to understand your credit score. In Canada, a credit score ranges from 300 to 900. A higher score is always desirable, but any score between 743 and 789 is usually considered good, and anything over 790 is very good. A score between 693 and 742 is considered ‘fair.’ Anything below 692 is considered ‘poor,’ which means you may have a more challenging time getting lenders to loan you money. These ranges are different when applying for mortgages and getting a reasonable interest rate, as you will read more of below.
In Canada, a credit score is determined by multiple factors: payment history, used vs available credit, credit history, public record, and inquiries. These factors are weighted at different amounts, with payment history usually carrying the most weight and the number of hard credit inquiries carrying the least weight.
Does your credit score affect your mortgage interest rate?
Many wonder if and how their credit score affects their ability to buy a house. The simple answer is yes; it absolutely affects your mortgage interest rate. The higher your score, the lower the interest rate you will usually get – and when you’re talking about a loan that is hundreds of thousands, if not millions, of dollars, a percentage or two makes a big difference.
Generally, a credit score of 760 or higher will give the borrower access to the best mortgage rates – as long as they have consistent income and meet the lending criteria such as the mortgage stress test. A credit score between 650 and 759 will moderately impact the mortgage rates available to you, but you may still have access to all mortgage rates available on the market. This is especially true if you have other factors on your side, like a hefty down payment.
As your credit score drops, so does your access to better interest rates. While in the past, a score above 680 was the minimum credit score requirement, Canada Mortgage and Housing Corp. (CMHC) dropped the minimum credit score requirement from 680 to 600 as of July 5, 2021. While this is good news for those who may be rehabilitating their credit score or those just starting to build credit, it doesn’t guarantee they will have access to the best mortgage rates. In fact, with a score below 680, the borrower will see rates incrementally increase. Typically, borrowers with a credit score of 600 would be considered “non-prime,” which means their mortgage rate would normally be about two percentage points higher than a “prime” borrower.
With a credit score of less than 600, it is almost impossible to get a mortgage from a bank in Canada. This is where B lenders and private mortgage lenders come into play. There are plenty of private mortgage lenders across the country with no minimum credit score requirement – this isn’t necessarily the best thing if you’re looking for a reasonable mortgage rate. Many private mortgage lenders will charge an interest rate substantially higher than the prime rate or even the non-prime rate that a bank will offer. These lenders may also tack on extra fees due to the borrower having poor credit as it gives them a type of insurance in the instance that a loan is defaulted on.
If you are thinking of buying a house soon, it may be a good idea to track your credit score and start working towards improving it if necessary.