May 22, 2014

Why It’s Important to do a Credit Check Before Applying for a Mortgage

You’re finally ready to take the plunge and buy a home… or are you? Before you start hunting for your dream place, a credit check is an absolute must. This essential step in the purchasing process will establish whether you’re qualified to carry a mortgage, and if so, the amount of financing you can expect to receive.

What is a credit check?

A credit check refers to the process of verifying an individual’s financial information, history and habits, usually for the purposes of approving a loan. This may entail assessing a credit score, a credit report or both. Lenders use these documents to weigh risk and decide on the appropriate amount.

Why a credit check is important

The results of a credit check determine how much you’re allowed to borrow and the rate of interest. It’s an essential piece in figuring out what kind of property you can really afford. And even if you always pay your bills within thirty days, knowing your actual score will help you negotiate the best possible rates.

It’s also a chance to ensure everything in your file is correct and avoid any surprises down the road. Unfortunately, credit reports are often riddled with mistakes, which can negatively impact your score. A national survey by the Public Interest Advocacy Centre found a 20 per cent error rate in which Canadians sampled said items on reports were inaccurate or should have been removed. Be alert to identity fraud as well.

How bad credit can hurt you

If you have a poor credit score or suspicious credit report, your request for a loan could be denied. You may have to delay purchasing or settle for a cheaper alternative. In extreme cases, you might never be able to own a home. Buyers should also beware that their information is kept on file for at least six years, and is not static either. As your credit score changes, so too could your home insurance rate. Watch out for this.

What is a credit score?

A credit score, which is commonly used interchangeably with “credit check,” is a mathematical formula that considers a number of factors – the key one being how consistently you pay your bills – and converts them into a three-digit number between 300 and 900.

Anything above 700 is considered good, while 600 is typically the minimum for obtaining a loan. Nearly 30 per cent of Canadians’ credit scores fall among 750-799. Remember that just 50 points more could mean saving tens of thousands of dollars over your mortgage’s lifetime.

What is a credit report?

A credit report is a detailed summary of your overall financial health. It contains personal information such as previous employers and financial information such as all credit cards in your possession. A scale of 1 to 9 is used, where 1 indicates that you pay your bills promptly and 9 signals that you have bad debt, never pay bills and may have been placed for collection or claimed bankruptcy.

The letter in front of the number represents the type of credit you are using: ‘R’ means you have revolving credit such as a credit card, ‘O’ means you have open credit such as a line of credit and ‘I’ means your credit has been granted on an installment basis.

How to do a credit check

There are two national credit bureaus: Equifax Canada and TransUnion Canada. Ideally, you should check with both. Anyone can order a free credit report by mail, fax, telephone or in person, but it doesn’t include your credit score. If, however, you opt to pay a fee to see it instantly online, it will include your score.

Why you should limit the amount of credit checks you have done

While checking your credit is a smart move and necessary for a major purchase, recognize that there can be too much of a good thing. Credit agencies don’t appreciate when multiple groups are digging into your background. It raises concerns, like why are you tapping into so much credit in a short timeframe? Three or more checks a year are red flags that drag your score down. The exception is when people are shopping around for mortgages or auto loans and get several “hard checks” within two weeks. Generally speaking, these will count as a single inquiry.

Tips on maintaining a good credit score

• Always pay your bills in full and on time. If you cannot pay the full amount, try to pay at least the required minimum shown on your monthly statement.
• Never go over the limit on your credit cards, and try to keep your balances well below the limits.
• Pay off your debts (such as loans, credit cards, lines of credit, etc.) as quickly as possible. Two or more missed mortgage payments can have a devastating effect on your score.
• Keep the number of credit card or loan applications you make to a minimum. Avoid signing up for several retail and department store credit cards – they all count as separate inquiries.
• The best mix of credit is a combination of one major credit card such as a VISA or MasterCard and one store credit card.
• The Financial Consumer Agency of Canada advises consumers shopping around for a car or a mortgage to do it within a two-week period.
• Once your credit score has improved, work with a mortgage professional to find a mortgage that works for you.

How you can learn more

The Financial Consumer Agency of Canada website offers a helpful, free guide: Understanding Your Credit Report and Credit Score.

Once you’ve checked your credit score, read Zoocasa’s Step-By-Step Complete Home Buyer’s Guide and learn how to prepare to buy your home.