10 Steps to Build Credit to Buy a Home

Building a credit history and credit score are important if you want to become a homeowner. A good credit score will help you qualify for an affordable mortgage when shopping around for your first home. In this article, we’ll look at some proactive steps you can take to build a good credit score before buying a home. These steps include regularly checking your credit report and score, disputing any errors on your credit report, and paying down any past-due accounts, among other things.

How to build your credit to buy a home

Here are 10 simple ways to build your credit when you want to buy a home.

Check your credit report and score

Before you even start building your credit, you should know where you stand. It’s a good idea to regularly check your credit report and credit score. By doing that, you can make sure your credit score is trending in the right direction. Making a regular habit out of reading your credit report can help you spot any errors or inaccuracies that may be bringing down your credit score and hindering your ability to get mortgage financing. There are free services that allow you to download your credit report so you can print and read it on a regular basis.

Dispute any errors on your credit report

By regularly monitoring your credit report for errors, you’re a lot more likely to spot them. When you spot fishy items on your credit report, you can take the necessary steps to dispute credit report errors. Both major credit bureaus, Equifax and TransUnion, have specific steps you must follow to dispute an error and have it removed from your credit report. Once you get the ball rolling with the credit bureau, it can take anywhere from a week to 30 days in time to dispute a credit report.

Pay down any past-due accounts

Payment history is the most important factor when it comes to your credit score. It accounts for 35% of your overall score. Mortgage lenders will want to see that all your payments are up-to-date before extending you any further credit. You’ll want to pay down any past-due accounts to show lenders that you’re a responsible borrower and can be trusted to make your payments on time.

Pay bills in a timely manner

You want to aim to always pay your bills on time. Ideally, you’ll pay off a bill in full. However, if you can’t afford to pay off the full amount in a given month, you’ll want to at least make the minimum payment. Revolving credit accounts (like credit cards) let you pay a lesser amount. You’ll want to make the full payments for installment loans, such as car loans, but you can pay as little as the minimum payment on your credit cards if cash flow is tight in a given month. 

Making a minimum payment on revolving credit accounts is seen as paying your bills on time in the eyes of the credit bureaus. That said, you shouldn’t make this a regular habit.

Apply for a secured credit card

If you have damaged credit or simply lack a credit history, a secured credit card can be a great way to rebuild or establish a credit score. By putting down a deposit, you’ll be able to obtain a credit card for the deposit amount. And by making your payments on time, you can help your credit score trend in the right direction.

Get a credit builder loan

A credit builder loan is a loan that you take out mainly to build credit. It achieves a similar goal as a secured credit card. By making a deposit up front, you can obtain a credit builder loan and show lenders that you’re able to make credit payments on time. This type of program can be a helpful solution if you are new to Canada and don’t have enough credit history established, or you have gone through a bankruptcy or consumer proposal and need to rebuild your credit.

Keep old credit accounts open

You might have an old credit account with a good payment history that you don’t use often. You may be tempted to cancel an old credit card. Instead of closing it, it’s better to keep it open. That’s because the length of your credit history is an important factor in your credit score. When you close an old account, your credit score may actually drop because you’re causing your credit history to shrink. This is the last thing you want to do while building up your credit score to buy a home.

Maintain a low credit utilization rate

Credit utilization is how much of your available credit that you’re using versus your total credit limit. By maintaining a low credit utilization, you’re demonstrating to lenders that you’re not stretched thin financially and have room to cover expenses. The gold rule is to keep your overall credit utilization rate under 30%. 

The opposite of this is maxing out your credit cards and lines of credit. Not only does this hurt your credit score, it could also be a red flag to a mortgage lender, as they may think that you’re stretching yourself too thin financially. Because of this, they may think you aren’t able to cover your bills and will be less likely to approve you for a mortgage (which is a substantial amount of money for them).

Get a credit limit increase on your credit card

If you find that you’re constantly exceeding 30% of your available credit with your everyday spending while using your credit card responsibly, you’ll want to consider getting a credit limit increase. A credit limit increase will make it so that you aren’t always approaching your credit limit going forward.

It will also help you reduce your credit utilization rate. As long as your spending remains the same, a higher credit limit will reduce the amount of credit you’re using out of the total amount available to you. Reducing your credit utilization rate this way can positively influence your credit score.

Pay more than minimum due

Lastly, you want to aim to pay more than the minimum amount due. While paying the minimum is better than missing a payment, if you’re constantly paying the minimum, it could hurt your credit score over time, especially if you’re always carrying a large balance relative to your credit limit.

What credit score Is required to buy a home?

The credit score you need to buy a home depends on how much you’re putting down. If you’re putting down less than 20 percent, you’ll need a default insured mortgage. As such, you’ll need a credit score of at least 600 to qualify for a default insured mortgage. That being said, it’s better to aim for a credit score of at least 680. That’s because many lenders require that you have at least this credit score to secure their most competitive mortgage rates.

If you’re putting down at least 20 per cent, usually you’ll need a credit score of at least 680. Otherwise, you’ll likely need to go with an alternative lender. An alternative lender can help get the job done, however, at a cost. Be prepared for higher mortgage rates and fees with alternative lenders.

What other elements do lenders consider when determining your creditworthiness?

Your credit history is an important element mortgage lenders consider when determining your creditworthiness when approving you for a mortgage, but it’s not the only one. There are other areas you should also focus on to improve your home approval chances.

For one, lenders look at your income. A lender wants to make sure that you earn enough to be able to pay your existing debts and the new mortgage you’ll be taking out on time. You’ll need to have enough income to pass the mortgage stress test with a prime lender.

If you’re a salaried employee, it’s usually as simple as providing a letter of employment. However, if you’re self-employed, a lender will usually want to see at least two years of filed tax returns.

A lender will also want to see that you have enough from your own personal resources to cover your deposit, down payment and closing costs. If you’re putting every penny towards those, that’s when it can raise red flags with lenders, as a lender will want to see that you have at least some liquid savings as fallback.

Who determines my credit score?

Your credit score is calculated by Canada’s two major credit bureaus, Equifax and TransUnion. They determine your individual credit score based on your behaviour with credit, which is recorded on your credit report. Credit bureaus analyze this information to calculate your score based on several factors, including your payment history, credit utilization and length of credit history, among other things. Your credit score helps determine how much you’ll pay when borrowing money for various purposes, such as buying a home or vehicle.

How long does negative information remain on credit reports?

If you have negative information that appears on your credit report, you can expect it to stay on there for about six years. However, some information stays on your credit report for more or less time, depending on the province or territory in which you live.

The negative information you can expect to see there includes any missed payments on credit accounts, any credit accounts sent to collections, and any consumer proposals or bankruptcies.

And even after the negative information is gone, if there’s a gap in your credit history, you may still need to provide lenders with an explanation as to why.

What is the fastest way to improve your credit score to buy a home?

A prime lender will usually want you to have at least two credit accounts open for two years with at least a $2,000 credit limit on each. This is referred to as the 2/2/2 rule. That being said, if you don’t meet the 2/2/2 rule, you may still be able to obtain mortgage financing.

If you’re new to credit, or you have bad credit and want to improve your credit score to buy a home sooner rather than later, there are some things you can do today to establish or reestablish your credit score.

The first thing you’ll want to do is obtain a free copy of your credit report and credit score. You’ll want to know where your credit score is currently at and figure out where you’d like it to be (i.e. high enough to qualify for a mortgage loan).

If you lack a credit score because you’re new to credit, you can sign up for a secured credit card to start building credit. If you have a credit score, but it’s on the lower side, you can determine why and take corrective action to improve your credit score.

A common reason for your credit score being low is that you’re using too much of your available credit. By paying down your balances, your credit score can bounce back relatively quickly.

If it’s not a spending problem and your credit card balances are almost always maxed out due to a lack of credit, you could request a credit limit increase to ensure you don’t go above 30% of your available credit limit on a consistent basis going forward.

Likewise, if some of your credit account payments are late, you can improve your credit score by making at least the minimum payment to get your credit accounts paid up to date.

Having too many hard credit inquiries may be another reason why your credit score is lower. By only applying for credit when you truly need it, it can help protect and rebuild your credit score faster.

Final thoughts

Building a credit score and credit history isn’t something that can be done overnight. However, putting the building blocks in place today and taking the necessary steps, you can be well on your way to homeownership in the near future.