How is your credit?

"How is your credit?”

If someone asks this question from you, you might wonder what it means, if you are a newcomer from Sri Lanka. In Canada, "credit" means your "creditworthiness" not anything else. It is not credit/debit in accounts. In other words credit means how reliable you are, for someone else to give you a loan.

In Sri Lanka you should have a good rapport with your bank to establish your creditworthiness then you have to stick to them for your financial needs. In Canada & the US there are central systems to monitor your creditworthiness. These places are called credit bureaus. There are mainly two establishments in Canada. So if you go to a merchant or a bank or a financial institution they can see how your creditworthiness is. This process is called "checking credit ". The credit bureaus assign a credit score to you on completion of the process of checking your credit. The credit score is an indication of your creditworthiness at that time.

There are two major things you should have to get a mortgage.

What are they ?

FIRST THING is Establishing good credit. This is an important factor, when it comes to purchasing a house. A good credit score will not only enable you to purchase a house, but will also enable you to get a good interest rate on your mortgage. On the other hand, a bad credit score will prevent you from getting your mortgage approved. Hence, it is extremely important to establish a good credit score.

How do we do this?

The credit score is computed based on five factors.

1.Payment History

This means how well you have paid off your loans in the past and has a 35% impact on your credit score. Settling your debts on time and in full has a positive impact on your credit score. In Sri Lanka, most people do not settle their credit card dues in full on the due dates. If we do this in Canada, it will result in a bad credit score. Late payments, judgments and charge-offs will also have a negative impact on your credit score. Missing a high has a more severe impact than missing a low payment. Hence, it is important to establish a good payment history by paying off all your dues on time. Here settling your debts in full means you must pay the minimum payment in full on time, however small that amount is.

2.Outstanding Credit Balances

This is the ratio of the outstanding credit balance to the available credit limit. The outstanding credit balances have a 30% impact on your credit score. Ideally, the outstanding credit balance should be at least 10% below the available credit limit. That means if you have a credit card with a limit of one thousand dollars($1000), outstanding balance should not be more than nine hundred dollars  ($900) at any given time. I usually advise my clients to not to exceed 80%  limit to be on the safe side. So that you reduce the risk of exceeding the limit.

3.Credit History

The credit history is the length of time since a particular credit line was established. This has a 15% impact on the credit score. A seasoned borrower will have a stronger credit score. Few years ago it was mandatory that you establish credit for at least one year for you to get a mortgage. However it is not that mandatory now a days if you have some other factors to your benefit.

4.Type of Credit

The type of credit that you have has a 10% impact on the credit score. A mix of loans – mortgages, credit cards, auto loans is more positive than a having only credit card debts

5.Credit Inquiries

The loan providers have to obtain your credit score before approving your credit line. The number of credit inquiries that have been made on a person’s credit history within a six-month has a 10% impact on a person’s credit score. Each hard inquiry can cost from 2 to 50 credit points, but the maximum number of inquiries that will reduce the score is 10. Eleven or more inquiries during a six-month period will not have a further impact on a person’s credit score.

We now know how the credit score is computed, and the factors impacting the score. But you would realize that you should first have credit facilities to build a good credit score. You would also realize that it will be difficult to get a credit facility approved, if you do not have a good credit score. So, how would a newcomer, who does not have credit facilities in Canada “build credit?”

One of the first things that you should do when you arrive in Canada is to get a credit card. As newcomers do not have a credit history in Canada, most banks now offer secured credit cards. A secured credit card is a credit card that you obtain by having a cash deposit as security. In addition, there are credit cards that are offered by retail stores – Bay, Sears, Canadian Tire etc. It may be easier to obtain a credit card from a retailer, than a financial institution. Once you obtain a credit card, you should make your purchases using this, but ensure you settle the entire bill on the due date at the begining. You should also ensure that you don’t make purchases up to the credit limit, so that you maintain a favourable ratio between the outstanding credit balance and the credit limit.

The next factor in building credit is to pay your utility bills on time.

SECOND THING is to have a sufficient income to pay your monthly mortgage.