Credit Scores and Their Effect on Canadian Mortgage Rates

Ask any Canadian who has gone through the home buying process what score is more important – last night’s NHL results or their Beacon Score – and they’ll most likely respond, “the Beacon Score of course!”. The reason being that a Beacon Score is one of the credit scores that lender’s use to measure a borrowers’ risk based on a valuation of their financial history including details on credit cards, charge cards, loans, mortgages and overall payment history.

In Canada, 3 private company’s generate almost all the credit scores – Equifax, Trans Union and Experian. Though all 3 bureaus offer FICO (Fair Isaac Credit Organization) scores using the formula developed by Fair and Isaac, each has its own brand name - Equifax calls it the Beacon Credit Score, Trans Union has the FICO score and Experian uses the Fair, Isaac Risk Model.

A high credit score is an important factor in applying and securing the mortgage and mortgage rate of your choice. It also makes it easier for an individual to get credit cards and loans on favorable terms, sometimes even with instant approvals. The higher your score, the lower the interest rate! The difference between a good and bad score can increase the cost of a loan by 3% or more.

Equifax is the most popular credit score used by lenders and results range from 300 to 900. The break-up is as follows:

A common misperception is that all inquiries will negatively impact your score instantly. The reality is that this may happen but its not a given and depends on your overall credit profile. The first inquiry can result in a drop of 5 to 20 points on the first mortgage inquiry, and will usually have a larger impact on the score for consumers with limited credit history and on consumers with previous late payments, but it’s different in every case.

Factors that affect your credit score

1. You have a short credit history

Age of your credit on revolving or non-revolving accounts also affects your credit score. Revolving accounts are credit cards such as Visa, MasterCard, or retail store card that allow you to make a minimum monthly payment and "revolve" the remainder of their balance over to the next month.

Non-revolving accounts include cards such as American Express and Diners Club and must be paid off in full each month.

Research shows that consumers with longer credit histories have better repayment risk than those with shorter credit histories. Also, consumers who frequently open new accounts have greater repayment risk than those who do not.

If you can maintain low balances and make sure your payments are on time, your score should improve as your revolving credit history ages.

2. You’ve been looking for credit in the past year

If you’ve been recently been seeking credit, this is evident on your credit file based on the number of inquiries in the past 12 months. Research shows that consumers who are seeking new credit accounts are riskier than consumers who are not seeking credit.

There are both credit and non-credit inquiries on the report and the score only considers those related to credit applications. Inquiries such as your bank reviewing your account or you requesting a copy of your own report are not considered.

The scores can identify "rate shopping" so that one credit search leading to multiple inquiries being reported is usually only counted as a single inquiry. For most consumers, a few inquiries on your credit file has a limited impact on FICO scores and the best advice is to only apply for credit when you need it.

3. Not paying off your loans

If you have installment loans and owe money on them, this does not mean you are a high-risk borrower. Paying down these installment loans is very positive as it shows that you are willing and able to manage and repay debt, and a successful repayment history is good for your credit rating.

One measurement is to compare outstanding loan balances against the original loan amounts. If you took out a $1,000 line of credit 1 year ago and still owe $925, this shows that you may be having trouble paying off the debt. Generally, the closer the loans are to being fully paid off, the better the score. This metric has limited influence on the FICO score.

Paying off loans on a timely basis reflects well on your credit score, but if you really want to improve it, try to pay the loans, (especially non-mortgage debt) as quickly possible.

4. Non-mortgage debt is too high

Consumers with larger credit amounts have a greater future repayment risk than those who owe less, resulting in the score measuring how much non-mortgage related debt you have.

The total outstanding balance on your last credit card statement is generally the amount that will show in your credit bureau report. Even if you pay these off in full each month, your credit bureau report may show the last billing statement balance.

Paying off your debts and maintaining low balances will help to improve your credit score. Consolidating or moving your debt into one account will usually not, however, raise your score, since the same amount is still owed.

Bankruptcy on the credit report is a borrower’s worst nightmare, as it stays on record for almost 10 years and reduces your score by 200 points or more.

Top tips to improve your credit score

1. Review your credit report at least once a year

2. Contact your creditors or the credit reporting agency to have errors on your credit profile corrected

3. Apply for credit only when you need it

4. Keep balances below 50% on your credit cards

5. Pay off non-mortgage debt on time as quickly as possible