Understanding and winning the credit crunch

As we all slowly make our way out of the holiday season, I would like to take this opportunity to welcome you back to my blog series. In my last post, we provided steps in understanding some of the “partner-factors” in purchasing and closing on a new home close to the holidays. While there are many factors, the biggest personal factor that we did not touch on, is your personal finance credit.

So, what exactly is credit? Most of us see our credit as a tool for what we have available for financial use. This tool or availability of monies can be used to buy big-ticket items such as houses, cars, and help to assist in financing renovations or other necessities we might see fit.

How we define personal finance credit, in reality, might mean two different things to two different people and what their perspective is with regards to the credit tools they have available.

My definition is that personal finance credit is credit, either in the form of a loan or mortgage from a certified lender, that is used with the understanding of paying those monies back with future income earned over a set period of time, or amortization rate.

Why is this important compared to other forms of credit, such as a credit card or even a line of credit? The number one reason is that this part of your “Credit Portfolio” is susceptible to large increases or decreases of buying power while being the largest form of credit that you can use towards those large-scale purchases such as a house. With the housing market being as robust as it has been in 2020 if you’re looking to purchase in March of this year, it’s more important than ever to understand what can affect your personal finance credit and how you can fix it in a relatively short time. In some cases, in less than 90 days.

Credit Score:

I always advise my clients, that it is to their disadvantage to go into a new lending situation with a credit score of less than 680. With a credit score of less than 680, the amount of credit (Mortgage) a lender is willing to lend, could be upwards of $60,000. Why is that?

• $60,000 is equivalent to four percent of your Gross Debt Service (GDS) over the lifetime of that loan.
• Your pre-approval could take longer and is not necessarily guaranteed (Pre-approval, what does it really mean?) when looking to secure a house in a seller’s market this is less than ideal.

CMHC Stress Test:

The “Stress Test” was new to the mortgage world regulation, introduced by the Canadian Mortgage and Housing Corporation in 2018. It put in place requirements that insured mortgage lenders check that applicants will, if required, still be able to make payments based on higher qualifying rates. This stress test is done by calculating the Gross Debt Service (GDS) and the Total Debt Service (TDS) of a client. However, as mentioned in my previous blog post (Making sense of the unsensical), this could have a detrimental effect on individuals and households trying to move up to a larger home.

Credit Cards

One of the biggest misnomers for personal finance credit is that having a lower limit credit card will not affect your ability to get a mortgage from your lender. This is one of the mistakes that I regularly advise clients to move away from. One of the main reasons is that lower limit credit cards are typically overutilized as a credit instrument. What do I mean by that?

Example #1: Client A, with a $500 limit credit card, purchases only groceries on the card. They use the full amount of credit and pays off the balance monthly. However, when it came time to make create their application, their credit check showed as having a balance and overutilization of their credit.

Example #2: Client B, with a $3,000 limit credit card, purchases roughly $500 worth of groceries on their cards as well. They pay the balance off monthly as well. When they came to me to start their application, their credit check showed as having a balance; however, it also showed that their credit card as a credit instrument was under-utilized.

These are the big three that contribute, in most cases, to a less than ideal situation for lending. They can impact you the greatest when it comes to your purchasing power. So how do we fix this? Prior to my work in the Real Estate and Mortgage Brokerage industry, I helped clients navigate these challenges as a finance industry expert for a major institution in Canada, and below are my recommendations that can help you navigate these pitfalls.

Credit Cards:

• I always advise my clients that you need to pay your balance off monthly, or at the time of the purchase. This will contribute to a better credit score and when making a new mortgage application will increase your chances of pre-approval.
• If you have a lower limit card that is overutilized ($500 limit but is used fully), call your lender or credit card provider and ask them for a higher limit. **Disclaimer: While I’m not advocating for spending more on these cards, this strategy will allow you, along with paying off purchases quickly, to show that you are underutilizing your credit cards as a credit instrument. In the short and long term, this will allow you to increase your buying power on numerous fronts: House, car, vacation property, etc. while allowing you to increase your credit score.

Credit Score:

• If your score is less than 680 there are two ways to increase that score in as little as 90 days to six months.
• If you regularly go to a gym or have a regular payment with a company (Cable or Cell Phone) that charges no interest on monthly payments, sign up for a monthly payment plan. This can help to impact your score positively, in some cases increasing your credit score by 100pts in 90 – 120 days.
• If you have student loans that are still in the process of being paid off, make sure those payments are made on time
• Lastly, the big one that has come up with past clients, if you’re looking to finance a new or new to you car within the same time that you are looking to apply for a new mortgage or renewal, WAIT! In almost all cases, this purchase will drive up your Total Debt Service (TDS) and will negatively impact the applications. However, having a mortgage that is serviceable and at a lower TDS will allow you to get that car in the future. We will touch on that in a future blog spot!

CMHC Stress Test:

• First check to see if your lender or bank works with the two other insurance lenders in Canada, Genworth Canada, or Canada Guaranty. They have slightly different qualification requirements, as well as not having imposed the restrictions on new lending. This might allow you more room to maneuver throughout the application process.
• Ensure that your TDS is lower than 42%, which includes your current mortgage, credit cards, and any payments being made to service your debt. This will provide you with the ability to have more buying power in a 2020 market that has been bullish.

As we move forward with 2021, thankfully and with a positive outlook, if there is one thing I can say it is that I will ABSOLUTELY continue to support you and provide the best possible advice, whether you are looking to purchase a new home or renew your existing mortgage. Let’s hope that 2021 can ring a little brighter for all of us.

Visit us virtually and let me help you navigate your journey through the process at Karigares.com.

All the best and Happy New Year.

Kari