“What’s my credit score?” or “How is my credit score calculated?” are some of the questions that I often hear as a mortgage agent. Credit score also goes by “beacon score” and “FICO” score depending on the agency that calculates the score. There is a certain cloud of mystery when it comes to credit score and how these credit bureaus calculate that score. Amid the mystery, credit scores are one of the most important factors when a lender is considering a borrower for a mortgage. The entire premise of credit scores can be confusing but to be honest they might be one of the most simple concepts. Credit score is just a calculation that measures an individual’s ability to pay debts, thus establishing a risk level.
Credit scores are calculated from a range of 300 to 900, 300 being the lowest possible score and 900 being the highest possible score. The lower the score the more risky the borrower is to the lender. This risk level also determines what lender will be willing to take on a certain borrower and what rate that lender can offer. As stated in an earlier blog, a credit score above 660 will be enough to get a mortgage with an A-side lender, allowing the borrower to receive the best rates on the market (providing the rest of the application is strong). A credit score below 660 is handled in a case by case situation as different lenders have different guidelines. A general rule is, the lower the credit the higher the rate and additional fees the client will be paying; however, there are ways to get around poor credit and high rates depending on income, equity and other factors. It gets complicated when explaining this aspect of the mortgage world so if you have a unique situation feel free to reach out with any questions.
In Canada there are two credit agencies: Equifax and TransUnion. Each lender will use at least one of these companies to decipher a credit score for their clients or potential clients. Both of these agencies will show different scores for the same client proving that their algorithms to generate a score are slightly different. Although there is a slight difference, both algorithms have the same core factors that calculate score:
- Credit Mix (10%): Having multiple types of credit such as credit cards, personal loans, line of credits , mortgages , etc
- New Credit (10%): looks at how many new forms of credit an individual is taking on in a certain time period. Not just having one credit card for years and no other forms of credit.
- Credit History (15%): How long credit accounts have been open (the longer the better as long as payments are being made)
- Credit Utilization (30%): How much of a balance is drawn compared to the limit. Don’t go over 50% of the limit. For example; if you have a credit card with a limit of $5,000 then you shouldn’t exceed a balance of $2,500.
- Payment History (35%): Late or missed payments, overdue accounts, bankruptcies and any written-off debts will all lower your credit score.
As seen above, payment history and credit utilization controls the largest portion of the credit score.
At the beginning of the blog I stated that credit “might be one of the most simple concepts”. I’m not saying credit scores are a simple concept because I’m in the mortgage industry or because I work with credit every day. Credit scores are a simple concept because I tend to not overthink them. It’s very normal to take on debt; almost everyone has or will take out a loan or use a credit card. Just don’t take on more debt than you can afford and make sure to pay off the debts when you take them on. The best advice I can give to raise a credit score is to use more than one form of credit every month and pay it off by the end of every month. If you can’t do that, set up minimum payments and don’t exceed 50% of available credit.
Don’t let credit scores get you confused or stressed out! If they do, reach out to me. I’m happy to help you figure out a solution