When it comes to buying your first home, there are lots of hoops to jump through ‒ including demonstrating that you have good credit so you can qualify for a mortgage. Your creditworthiness all comes down to one thing: your ability to manage debt. It’s how lenders determine whether they’ll lend you money. A higher credit rating can also mean a lower interest rate: one that saves you thousands over the life of your mortgage.
So how do you get that great credit rating? We talked to James Harrison, Mortgage Broker at Mortgages.ca. He says there are several attributes that lenders consider before granting credit. Commonly referred to as the “five Cs, they include character, capacity, capital, collateral and conditions. Let’s take a closer look at each one:
1. Character
The determining factors for your credit character include:
Whether you habitually pay your bills on time
Whether you have any delinquent accounts
Your total outstanding debt
How you use your available credit
Quick tip: Using all (or even most) of your available credit isn’t a good idea. It’s better to talk to your lenders and have your credit limit increased than using up more than 70% of what you have available each month. For instance, if you have a limit of $1000 on your credit card, you should never go over $700. To increase your score faster, use less than 30% of your credit limit. If you need more, pay off your credit cards early so they stay below 30%.
2. Capacity
This is your ability to pay back loans. It looks at your cash flow versus your outstanding debt, as well as your employment history. Capacity isn’t what you think you can handle: it’s what the lender has determined you can afford. They use your debt service ratio to make that decision: it’s your total monthly debt payments divided by your gross monthly income.
Read more: How much can I afford?
3. Capital
Capital is the amount of money that a borrower puts towards a potential loan. For mortgages, the starting capital is your down payment. A bigger down payment often means better rates and, in some cases, better mortgage terms. For instance, a mortgage with a down payment of 20% doesn’t require default insurance, which is an added cost.
Read more: Saving up for your down payment - 17 smart strategies
4. Collateral
Collateral is what is pledged against a loan for the security of repayment. For auto loans, the loan is typically secured by the vehicle itself: the vehicle can be repossessed and resold if the borrower defaults. With mortgages, lenders typically consider the value of the property you are purchasing and other assets.
5. Conditions
The conditions of the loan can also influence the lender's desire to provide financing. Things like interest rate, terms, and the length of the loan are all factors.
If you need to build better credit before you can buy your first home, there’s no time like the present to get your financial ducks in a row. Not sure where to start? A mortgage broker can help you determine your current credit score and see where you can improve things to help you get a better interest rate and mortgage.
Want to get the scoop on getting a mortgage? Read Mortgages 101 in our First-time Buyers Hub.