In order to buy your first house (and every house afterward) you’ll need good credit. This can be broken down into 5 C’s: Character, Capacity, Capital, Collateral, and Conditions. With a firm grasp of these 5 C’s you’ll be able to make your first home purchase using another C: Confidence.
Before you lend somebody something you want to be able to trust that they’re going to give it back. In other words, you want to know they have good character. Mortgage lenders want to know the same thing about you before they agree to lend you the money for your mortgage. The lender doesn’t know you personally but in order to find out what kind of character you have they can look into your credit history.
Every service or credit product you have submits credit reports for each payment cycle. This includes things like your cell phone bill, utility bills, credit cards, and other loans. If you gave the provider your social insurance number chances are they’re sending in credit reports.
Lenders will look into your credit history (with your permission) to find out if your accounts are in good standing. They can see if your accounts have been paid on time and they can view your credit score. Your score will be anywhere between 300 and 900.
Having your credit history and credit score will help you to know where you stand and how likely you are to get approved by lenders, for how much, and at what interest rate.
- Review your credit history This can be done through Equifax or TransUnion. Reviewing these reports will tell you exactly which of your bills affects your credit and will also give you the chance to make sure there are no errors in the reports. You should also make sure there are no reports you don’t recognize as these may be fraudulent.
- Find your credit scores Most mortgage lenders will use your Equifax credit score but they will also look at your TransUnion score. (Each company uses different calculations to determine your score.)
- Get lender details Many lenders group credit scores into tiers. The better your score the better your mortgage options. If it turns out your score is just a few points away from the next best tier it may be worth it to take the time to improve your score before you apply for your mortgage.
Capacity is based off of your income and indicates your ability to pay back your mortgage. Lenders will also look at how long you’ve been working for your current employer. They will get this information using your most recent tax return and recent pay stubs. This income and employment history will tell the lender how consistent and reliable you are financially.
Lenders will also look at how much money you have tied up in pre-existing debt. This is called your Total Debt Service ratio (TDS). The ratio is calculated by tallying your monthly debt payments and dividing it by your total gross monthly income. This ratio is important to prospective lenders because they want to know how much additional debt you can reasonably handle. Your TDS should not be more than 44%. The TDS ratio is one part that determines your credit score and also impacts your ability to get credit products like a mortgage, credit card, or other loans.
- Lower your TDS ratio If you have a high TDS ratio do some work to bring it down. You can do this by increasing your income or decreasing your debt.
- Increase your savings A high TDS ratio can be compensated (in part) by a large savings or other liquid assets.
- Downsize your property search If buying a large home will make your TDS too high consider instead the option of purchasing a smaller home.
- Research the “other” costs of homeownership Walk into your mortgage with both eyes open by looking into the property expenses beyond the down payment and mortgage. Read here for more information.
If you have savings, investments, assets, or properties you have capital. Many homebuyers may feel tempted to pour all their capital into their home purchase, but it is not wise. Having a “cash cushion” will make you feel better should you fall on hard times, and it will reassure your lender that you’ll be able to continue making your payments.
- Talk to the lender Find out what kind of capital your lender wants you to have
- Look at yourself Honestly consider how much of a “cash cushion” you need in order to feel secure.
Collateral is what you have to offer the lender if you can no longer pay for your mortgage. Usually the property itself is the collateral and a home inspection will be done before the mortgage is finalised. However, if you put less than 20% down on the home your mortgage will have to be insured by CMHC (Canadian Mortgage and Housing Corporation.) CMHC provides the collateral for the home in this case and you’ll have to pay the insurance. If you want to avoid this additional cost you will have to make a down payment of at least 20%.
- Research lender requirements Whether you go with a typical lender like a big bank, end up using a down payment assistance program, or pay for CMHC insurance, find out what kind of collateral requirements your lender has.
The first four C’s have to do with your personal circumstances, whereas this C is out of your control. Conditions include things like supply and demand, mortgage and interest rates, and the cost of living. In this case the best thing you can do is research.
- Get a pre-approval A mortgage pre-approval is an application sent to a lender to find out how much they may be willing to give you for a mortgage and at what rate of interest. You have the option of filling out a pre-approval with lender after lender, but this can hurt your credit. The better option is to work with a mortgage broker who will submit your application to multiple lenders at once, and your credit will only take one hit.
- Consider your options Many first time homebuyers only think of getting a mortgage with a big bank, but there are many different lenders to consider. Small banks, credit unions, mortgage companies and others. A mortgage broker can help you do the research and get you the best deal for your needs.
Bringing the 5 C’s of credit together bring you to a 6th C: Confidence. Knowing what your credit it, how to improve it, and how to use it will make you an intelligent and prepared buyer! Contact us today to get started or for more information.