What does it take to be a homeowner? A down payment, certainly. A good job, yes. Strong financial planning, absolutely. And how about credit? How can you know if you’ve got good credit? And if you don’t, how can you make it stronger?
Here are the 5 C’s of credit for first time home buyers: Character, Capacity, Capital, Collateral and Conditions.
Lenders want to know if you’ve you’re going to pay your mortgage back as agreed. This is what we mean by character. The one main way lenders check your character is by looking into your credit history.
If you pay a company for a credit product like a credit card or loan, or if you pay for a service like a cell phone, utilities or sometimes even rent, there are bound to be credit reports on your payment history. If you gave the company your social insurance number they’re probably filing reports each month.
When you give a lender permission to “check your credit” they are able to review these credit reports to see how often you pay your bills on time. The lender will have access to your credit score as well. You score can be anywhere between 300 and 900. Your lender isn’t the only one who should know your credit score, you should know it too! Knowing the details on your credit reports and score will help you to improve your rating and thereby your chances of getting a good mortgage (or other loan.)
- Check your credit reports You can get copies of your credit reports from TransUnion and Equifax. This will show you which of your providers sends credit reports. Look through them carefully. Be sure to report any errors as well as any reports for goods or services you don’t recognise. Unfamiliar reports can be a sign of credit fraud which can hurt your credit!
- Check your credit scores Every lender has its own formula to determine your overall credit score. But they will look at both your TransUnion and Equifax scores, so it’s important that you understand how both work. Having a good idea where your credit stands will help you know what financial position you’re in.
- Get lender information Most lenders will place credit scores into ranges. Each range will have access to certain products at certain costs. The better your credit the better interest rates you may be able to access. If your credit is just outside a better range it may be worth it to improve your credit before applying for your mortgage.
Capacity refers to your how much mortgage you can afford. It is based off of your income and how long you have been in your current place of employment. You will provide the lender with your most recent tax return as well as recent pay stubs to prove your current income.
Lenders will also look at your debt to income ratio. This is also referred to as your Total Debt Service ratio (TDS.) This ratio is calculated by tallying your monthly debt payments and dividing it by your monthly pre-tax income. With this ratio lenders are able to determine how much extra debt they feel comfortable lending you. Your TDS isn’t the main aspect lenders look at when deciding if and how much to lend to you, but it will affect your ability to get access to credit products in general.
To find out what your own TDS ratio is start by adding up your monthly debt payments. Then divide that number by your total monthly gross income. This number, including your mortgage, should not be more than 44%.
- Decrease your TDS If your TDS ratio is higher than you’d like do some work to bring it down. You can manage this by increasing your income or decreasing your debt.
- Grow your savings If your TDS is high you can compensate for it by having liquid assets or a large savings.
- Downsize your home search If buying your dream home is going to send your TDS into the stratosphere you can instead limit your home search to properties with a smaller price tag.
- Look at the total cost of homeownership Everybody expects to pay a mortgage and utilities when they buy a home, but far too many are unaware of the additional expenses that come with property ownership. Read here for more details on what you can expect to pay above and beyond your mortgage. With this in mind you’ll be better able to plan your budget.
It might be tempting to pour every dollar from your savings into your down payment, but your lender won’t like it and you’ll be feeling pretty strapped for cash yourself. Instead, hold on to some of it in case you suddenly find yourself facing a financial emergency. Capital includes things like savings, assets, investments, and properties. Having a bit of a “cash cushion” will give your lender reassurance that you’ll be to make your mortgage payments even if “life happens.”
- Ask how much the lender wants Find out how much of a “cash cushion” your lender would like to see.
- Figure out what works for you The lender’s reassurance is important, but so is your own! Figure out how much of a “cash cushion” you need to feel comfortable in the event of a financial emergency like an unexpected repair or job loss.
Collateral is like insurance. The lender says “we’ll give you this money but if you fail to pay us back as arranged we’ll take [fill in the blank] from you.” In most cases the home itself is the collateral. In addition, if you put less than 20% down on your home you will have to pay for CHMC insurance (Canada Housing and Mortgage Corporation.)
- Ask for collateral requirements Whether you use a traditional lender like a big bank, a small lender, if you use a down payment program or have to use CMHC insurance, find out what the collateral requirements are before agreeing to the mortgage.
The last C, conditions, is out of your control. Conditions refer to things like supply and demand, interest rates, mortgage rates, and cost of living. The only thing you can do here is research.
- Get a mortgage pre-approval A pre-approval will tell you how much a lender may be willing to give you and at what interest rate. You have the option to go from lender to lender filling out one application after another, but it will hurt your credit. The better choice is to work with a mortgage broker who will submit your application to multiple lenders simultaneously with only one soft hit to your credit.
- Look outside the box It is typical for many new homebuyers to look at only their existing bank for a mortgage. There are many options including small banks, credit unions, and mortgage companies. Doing a bit of research will help you find the best options available!
Character, Capacity, Capital, Collateral and Conditions. These 5 C’s lead to one more: Confidence. After doing your research you’ll be able to go forward feeling confident that you got the best deal around! To get started with a mortgage broker today, give us a call!