A credit score is a number that represents your ability to pay back credit to a bank or lender. Why is a credit score important when applying for a home loan? A home loan is likely to be one of your biggest lines of credit and can extend up to 30 years. Because of this, banks and lenders use credit score ratings as part of their assessments when evaluating a home loan application. It helps to determine whether you will get the credit you’re applying for based on your risk profile and credit history.
Some credit bureaus rate credit scores between 300 and 850. A low score is generally considered to be between 300 and 579. A fair score is between 580 and 669. A good score is anything above 700. This is where you want to be!
A high credit score is great when buying a home because banks could offer you a lower interest rate because you’re less of a risk; and the loan to value you will qualify for may be higher. Loan to value is the deposit you may need to pay towards the purchase price of a property. A better credit rating means a lower deposit.
A lower credit rate means you pose a higher credit risk, and this may affect your ability to get a bond.
So, what affects your credit score? There are a variety of factors that come into play.
- Reliance on credit to pay your expenses. Do you earn enough, after expenses, to pay your monthly credit? If you are in a position where you use credit to pay off other credit, you’re likely to have a lower score and pose a higher risk to lenders. Some experts caution against using more than 30% of the credit line available to you as this can be an indication of risk.
- The amount of serviceable credit you have. Serviceable credit basically means the amount of debt you have that you can regularly and consistently pay off each month. Having a well-managed amount of credit helps increase your score, as it shows you can handle your money, debt and payments responsibly.
- History. The period you’ve had credit and how that credit has been managed over time plays an important part in determining your rating. Often banks and credit bureaus will look at how long you’ve had your oldest accounts for and how those have been managed over the loan period. Anything from five to 10 years of well-managed credit lines puts you in a better rating position. Your history of credit applications is also considered. If you’ve applied for a lot of credit within a short period of time, this can be a red flag. Also, being declined for credit, undergoing a debt review or debt counselling can negatively affect your credit score.
Tips to improve your credit score.
Multiple lines of credit
Showing lenders that you can manage multiple lines (or types) of credit well can increase your rating. Being able to pay your cellphone contract, retail account and credit card every month means you’re a lower risk. But be careful to limit the number of lines of credit you have. Aim for a maximum of 10 different types of credit across a variety of services and lenders.
How you use your credit makes a difference. Using your credit card for frivolous spending doesn’t make sense and can show patterns of irresponsible spending behaviour, like buying luxury and non-essential items. Use your credit conscientiously and for its intended purpose.
Period of credit
Have a mix of both long-term credit (home loan, car) and short-term credit (retail account, cellphone contract), as both have different weightings on your credit score.
Create a repayment plan you can realistically manage. Review your current credit and ensure you can pay off each one every month. If you’re struggling, be upfront with your credit provider and work together to find a solution. It’s better to negotiate payment terms than not pay at all.
Close lines of credit that you no longer need. Keeping them open “in case” may not be the best idea. Where possible, reduce your overall credit balance as much as possible. Try to pay a little bit extra from time to time (if your loan agreement allows for it); this shows that you are disciplined and want to pay your debt off as quickly as possible.