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Bad credit can hurt you under new mortgage rules

<i>[Your credit score can affect how big a mortgage you can now get.]</i>
[Your credit score can affect how big a mortgage you can now get.]

Millennials are swapping dreams of a white-picket fence and yard for strata fees and shared elevators now that Canada’s new mortgage rules have come into place.

At the centre of the regulations are a built-in “stress test” for all insured mortgages. It means that even though rates are currently at historical lows, borrowers need to be able to prove they can handle payments if the rate was higher. Buyers putting less than 20 per cent of the purchase price down are being judged against the standard rate of 4.64 per cent for a five-year loan, even though they’re likely able to secure a much lower rate.

As a result, most people will qualify for less money, making the news especially painful for first-time buyers in particular.

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There’s another factor that can affect how much buyers will qualify for within the new mortgage rules that’s often overlooked: credit scores.

A low credit score could knock off four per cent of qualifying room for a mortgage, according to Mogo financial fitness coach Chantel Chapman. Based on the 2014 median total income of Canadian families of $78,870, that could amount to a difference of $35,000.

When it comes to qualifying for a mortgage, lenders look at your Gross Debt Servicing Ratio (GDSR) to assess how much you can borrow. That amount varies based on your credit score.

Consumers applying for a mortgage with a credit score of 680 or more will be allowed a GDSR of 39 per cent (which is the ceiling), whereas those with a credit score less than 680 will be allowed a maximum GDSR of 35 per cent.

“Your credit score is basically your financial report card,” Chapman says, explaining that credit scores range from 300 to 900. “The more positive credit history you have the better. Typically, mortgage lenders like to see at least two forms of active credit reporting for the last two years.”

Credit scores are determined on an algorithm that’s made up of different aspects of your credit history: payment history (35 per cent), utilization ratio (30 per cent), length of credit (15 per cent), types of credit (10 per cent), and inquiries (10 per cent).

“The two main things that can impact your credit are missing payments and your utilization ratio—how much of your debt you have used,” Chapman says. “The mortgage rule changes are out of your control, but having a strong credit score is in your control. So, if you’re planning to own a home, it’s good place to start.”

Credit reports are maintained by at least one of two of Canada’s reporting agencies: Equifax Canada and TransUnion Canada. Several organizations or individuals can access your credit history aside from banks and mortgage lenders, such as cellphone companies, insurance corporations, governments, employers, and landlords.

For a strong score, “a consumer should make sure she or he pays off bills on time, has a balanced mix of credit products, has low usage on credits, has no outstanding collections or bankruptcy, and only apply for the credit when needed and not all at the same time,” says Arthur Lam, consumer and verification verticals leader at Equifax Canada.

Depending on the reason for a weak credit score, it could take some time to build it back up.

“If your score is low strictly based on utilization, it could improve in approximately 30 days if you pay down your balance below 70 per cent,” Chapman says. “Paying down your debt mid-month instead of waiting till the end of the month will also help improve your score faster. However, if your score is low because of your payment history, it will gradually improve over approximately 12 months with on-time payments.”

There are several things aspiring home owners looking to get approved for a mortgage can do to build a strong credit score.

Check your score and monitor it on a regular basis.

Be sure to check with both Equifax Canada and TransUnion Canada. There’s a fee for online reports, while those sent by mail are free. Equifax also partners with Mogo Financial Technology Inc. and Borrowell to provide free credit scores.

“We always encourage consumers to take early control of their credit usage and build towards having a good credit history,” Lam says. “Consumers should check their credit report at least once a year to check for inaccuracies and prevent fraud. It’s just good practice because it helps consumers gain control over their finance and credit history.”

Take care of late or outstanding payments. Do an inventory and make sure all minimum payments are up to date.

“Don’t miss any payments, ever,” Chapman says. “Missing $4 on a payment is the same as missing $400 in the eyes of the credit score algorithm.”

Stay below your credit limits.

Chapman suggests setting an imaginary limit of 70 per cent of your approved limit on your credit cards and lines of credit

“Do not go over it—even if you pay your balance off every month,” she says. “Doing this will keep your credit score healthy. If you tend to carry a balance on your credit card, try to keep it under 35 per cent of your total credit card limit.”

Avoid having several credit checks at once.

“It’s in your best interest to be 100 per cent aware of who does hard credit checks to avoid major drops in your score,” Chapman says. “Multiple hard credit checks in a short time could impact your score because inquiries account for 10 per cent of your overall score. Most lenders will do a hard credit check during the loan approval process, and even some new cell phone plans require a hard check.”

Get started on building credit history.

“If you don’t have a credit history, there is a simple fix, Chapman says. “Get a credit card with a small limit and pay it back on time. For example, pay your Netflix with your credit card, then your credit card automatically with your bank account—and leave your credit card at home. You’ve now set up a loop to keep you out of debit while you build up your credit history.”