Why your credit score matters when you’re buying a home

With the new mortgage rules coming into effect across Canada, you might be wondering what that means for you—and whether you can still enter the market. One of the new rules applies a stress test to borrowers, which means you need to qualify at a higher rate when you have less than 20% as a down payment. Before these new rules, mortgage borrowers who took a 5-year fixed-rate mortgage only had to qualify for the mortgage payment based on the interest rate they were getting.

Now with the new rules, you’d have to qualify for a rate at the Bank of Canada’s 5-year fixed posted rate, which is currently 4.64%.

The new rules aim to make sure that if interest rates ever go up and are much higher than they are today, homeowners will still be able to make their payments. But the result is also an approximately 20% decrease in the amount of mortgage money available to borrowers.

One factor that you can focus on that is within your control to maximize your affordability: your credit score. A higher credit score could result in a higher mortgage pre-approval amount.

Canadian lenders have to follow specific rules for mortgages with a down payment that’s less than 20%. These rules are set by qualifying ratios called Gross Debt Service Ratio (GDSR) and Total Debt Servicing Ratio (TDSR).

▶ GDSR is your mortgage payment, heat, taxes, and strata payment applied against your monthly income.

▶ TDSR takes the calculation above and adds other debts like credit card debts, line of credit, etc. and applies that against your monthly income.

▶ If your score is under 680, your max GDSR is 35% and your max TDSR is 42%

▶ If your score is over 680 you max GDSR is 39% and your max TDSR is 44%

▶ Higher credit scores get rewarded with an additional 4% GDSR and 2 % TDSR

Basically, a low credit score could knock off 4% of qualifying room for a mortgage. Based on the median total income of Canadian families, listed as $79,000 (from Statistics Canada 2014), that could amount to a difference of about $27,000 on your mortgage.

For example, someone whose credit score is 650 with a median household income, whose additional debt is $400 a month, will have a GDSR of 35% and a TDSR of 42%. At that calculation they’ll be approved for a mortgage of about $378,000 (based on today’s 5-year posted rate and 25-year amortization). Take all of the same factors but when applied to someone with a credit score of 750; their GDSR will be 39%, and TDSR 44%, giving them a mortgage of over $400k. That’s a significant difference when it comes to buying a home. (see graph)

The two main things that can impact your credit are: missing payments and your utilization ratio (how much of your debt you have used).

If your score is below 680, good news: you can improve it. If it’s low strictly because of utilization, it could improve in as little as 30 days if you pay down your balance so it’s below below 70%. Paying down your debt mid-month instead of waiting until the end of the month will also help increase your score faster. If your score is low because of your payment history, it should gradually improve over about 12-18 months with on-time payments.

The mortgage rule changes are out of your control, but having a strong credit score isn’t. If you’re planning to own a home, it’s good place to start!