Preparing Credit

HOW TO REBUILD YOUR CREDIT

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Having good credit is an important part of your financial health. It can allow you to access the best quality credit products on the market. When you’re looking to take out a car loan or a mortgage, lenders look to your credit score when deciding to approve or decline your application.

Credit scores fluctuate according to your borrowing and repayment habits.

If you have had difficulty managing your finances in the past, missed payments or entered a debt relief program, like a consumer proposal or bankruptcy, your credit score will be negatively impacted.

With the right tools and resources, you can rebuild your credit. The important thing to keep in mind is that it takes time. Building credit is cumulative: it’s all about repeating positive behaviours and knowing which mistakes to avoid.

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Understand how credit works

To rebuild your credit, the first step is making sure you understand how credit works. Every time you borrow money or apply for credit, the lenders send information about your account to the credit bureaus (Equifax and TransUnion), who then add the information to your credit report.

A credit report is a detailed report of your credit history, including a credit score and credit rating. It shows a summary of the amount and all types of credit you have, the length of time you have had these accounts, and your track record in paying bills. It is updated on a regular basis by companies that lend you money or issue credit cards (banks, credit unions, etc.).

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How is your credit score calculated?

 

Credit scores reflect a person’s borrowing habits, what they do or don’t do with the credit they have been given. A number of factors go into determining a credit score.

• Payment history (35%)

  Do you consistently make your payments on time? Your payment history is the most important component of your credit score. It includes all your past payment information, including payment deferrals, late and missed payments, collections and debt relief programs, like a consumer proposal or bankruptcy.

• Amount owing (30%)

  How much room do you have left on your existing debts? Having a balance of less than 30% of your credit limit is best, but if you have maxed out a credit card, lowering your balance by any amount will help improve your credit.

• Length of credit history (15%)

  The longer your credit history is, the more accurate your credit score will be in determining your borrowing habits.

• New credit applications (10%)

  How often do you apply for new credit? Credit agencies are notified every time a lender checks your credit following a credit application. So, avoid frequent “credit shopping,” which can lower your score.

• Types of credit used (10%)

  Having a credit history that includes different kinds of credit can reflect favourably on your credit score, like installment loans (car loans, personal loans), revolving credit (credit cards), or open credit (lines of credit).

 

* Remember that your credit score can vary between financial institutions and credit bureaus. Other factors like your income, assets, the length of time at your current job can all be a part of a lender’s decision making process for assessing your risk level as a borrower.

 

Check Your Credit Reports

When you apply for a home loan, the mortgage lender will look for three main things. The first is that you—and your spouse if you apply jointly—have a steady income. The next consideration will be how much of a down payment you can make. The final piece is whether you have a solid credit history.

Your credit history lets lenders know what sort of borrowing you've done and whether you've repaid your debts on time. It also tells them whether you've had any events such as a foreclosure or bankruptcy.

Checking your credit report will let you see what the lenders see. You'll be able to find out whether there’s anything that’s hurting your credit.

To check your credit report, request reports from the three credit bureaus: TransUnion, and Equifax. Since you don't know which credit reporting agency your bank will use to evaluate your credit history, you should get a report from both.

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Dispute Inaccurate Information

Carefully review your listed credit history for any mistakes. Wrong information may hurt your credit score, causing your application to be denied.

If you spot inaccurate information, dispute it with the credit bureau. Try to find documentation to support your claim; providing proof of the mistake will help ensure that it's removed from your report.

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Pay Off Delinquent Accounts 

If you have any delinquencies, pay them off. Outstanding delinquencies will show up on your credit report, harming your chances of getting a mortgage. Delinquent accounts include any late accounts, charge-offs, bills in collection, or judgments.

Debts that are in collections will affect the payment history portion of your score, which is the biggest component of your credit score. Attempting to repair those problems is a good idea, because lenders may use them when evaluating your mortgage application.

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Bury Delinquencies with Timely Payments

Late payments can stay on your credit history for seven years, but they're most damaging when they first occur.

If you have a recent late payment—or you've just paid off some delinquencies—try to wait at least six months before applying for a mortgage.

This six-month period will allow the older delinquency to fall further down your record and look less damaging. Meanwhile, six months of on-time payments can help your credit score build back up again.

You need to establish a pattern of making timely payments to get approved for a mortgage. The better your history, the better and more competitive the interest rate you will receive on your mortgage.

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Reduce Your Debt-to-Income Ratio

Your bank's mortgage underwriter will question your ability to make your mortgage payments if you have a high level of debt relative to your income. Otherwise known as your "debt-to-income ratio," this figure compares the money you owe (your debt) to the money you having coming in (your income).

Lenders like to see this figure as low as possible. In fact, to get a qualified mortgage, your debt-to-income ratio must be below 43%. In other words, you can't be spending more than 43% of your income on debt.5

To reduce your debt-to-income ratio, you can increase your income, perhaps by getting a better-paying job. But it may be easier to decrease your debt by paying down any outstanding loans or bills and not borrowing more than you can afford.

 

Don't Incur Any New Debt

Taking on new debt can make a mortgage lender suspicious of your financial stability—even if your debt-to-income ratio stays low. It’s best to stay away from any new credit-based transactions until after you’ve got your mortgage secured.That includes applying for credit cards, especially since credit inquiries affect your credit score. It also includes auto loans and personal loans, to be safe.

Once you've locked in your mortgage and closed on the house, then you might wish to explore other new debt.