How Does Your Credit Score Affect Your Mortgage Interest Rate?

Mortgage rates have steadily dropped as Bank of Canada cut interest rates twice this summer and with more decreases anticipated the rest of this year. While lower interest rates result in better affordability for aspiring buyers, credit scores are still critical for qualifying for a mortgage.

Your credit score is more than just a number – it's a critical factor that can significantly impact your financial life, especially when it comes to major decisions like securing a mortgage. As you explore the journey of homeownership, understanding the relationship between your credit score and mortgage interest rates is key.

In this blog post, we'll delve into the world of credit scores, demystify their significance, and unveil the way they influence the terms and conditions of your mortgage. Whether you're a seasoned homeowner or a first-time buyer, the knowledge about how your credit score affects your mortgage interest rate can make all the difference.

What is a Credit Score?

A credit score is a three-digit number that represents your creditworthiness in the eyes of lenders. They range from 300 to 900, and the higher your credit score, the better. Your score is calculated by credit bureaus based on the information in your credit report. The two main credit bureaus in Canada are  Equifax and TransUnion. Financial institutions use this information to help make decisions about the services and products they offer you, such as interest rates and insurance premiums.

Your credit score is affected by your history of using credit: how much you have, how long it takes you to pay back, what type you have, and how long you’ve had it. 

If you have a credit score of 741 or greater, you’re considered to have an excellent credit score. A credit score of 713 to 740 is considered good. 660 to 712 is considered fair. Anything below that is considered below average to poor. This is important, as your credit score can make all the difference in whether your mortgage application gets approved or not.

The Link Between Credit Scores and Mortgage Interest Rates

A credit score helps predict your behaviour when it comes to credit. It tells a lender how likely you are to pay back a loan on time.

A mortgage represents a large sum of money. In fact, it’s most likely the largest sum of money you’ll borrow in your lifetime. That’s why your credit score matters so much.

The better your credit score, the better the mortgage interest rate you’re likely to be offered. This is because the lender sees you as trustworthy, and they have confidence that you’ll be able to make your monthly mortgage payments. 

If you have a credit score of at least 720, you’ll typically qualify for a lender’s best mortgage rate. If your credit score is below 720, that’s when your mortgage rate may be higher, to account for the extra risk the lender is taking on by approving your mortgage.

What is the Minimum Credit Score Needed for a Mortgage in Canada?

Before we discuss the minimum credit score needed for a mortgage, it’s important to understand the difference between an insured mortgage and a conventional mortgage. When you put down less than 20% of the value of the property you’re purchasing, you will be required to pay mortgage loan insurance on top of your mortgage payments, and this is known as an insured mortgage.

For an insured mortgage, the minimum credit score is 600. This requirement is a little lower than for an uninsured mortgage, and that’s because, when the mortgage is insured, the lender is protected by the insurance if you fail to make your payments.

For a conventional, uninsured mortgage, the minimum credit score required is usually 660, although the higher the better of course.

Can I Get a Mortgage with a Low Credit Score?

If you make a down payment of at least 20%, you have the option of going with an alternative or private lender if you can’t meet the minimum credit score requirement. However, that comes at a cost, as typically you’ll have to pay a higher interest rate and this kind of mortgage usually comes with lender fees.

Another route is to consider co-signing your mortgage with someone else, perhaps a family member that you trust. An ideal co-signer is someone with a better credit score than you. Having a co-signer will give the mortgage lender further reassurance, as the co-signer would be fully responsible for making the payments if you stop being able to.

How To Improve Your Credit Score To Get a Better Interest Rate

Are you looking for ways to improve your credit score and qualify for a better interest rate? Here are some things you can start doing today to do just that.

• Make All Payments On Time: Making your payments on time is the single most important factor when it comes to your credit score. If you can’t afford to make your full payment, at least make the minimum payment so that you maintain a positive track record of making your payments on time. This will go a long way to building your credit score.

• Reducing Credit Utilization: Credit utilization refers to how much of your available credit you’re using. The more you’re using, the more nervous lenders tend to get. Ideally, you want to be using less than 30 percent of your available credit. So for example, if you had a credit card with a credit limit of $3,000, you would want to keep your balance below $1,000 at any given time.

• Addressing Errors On Credit Reports: If there are any errors on your credit report, you want to get them corrected right away. It’s a good idea to regularly review your credit report for this reason. That way you can spot errors immediately. Errors can delay your mortgage approval or even cause an application to be declined in the worst-case scenario.

• Build your Credit Score with your Rent Payments: With Borrowell Rent Advantage, you can report your rent payments to Equifax (Canada’s largest consumer credit bureau) so that you rent helps you build your payment history, credit history and credit mix: three factors that can have a big impact on your credit score. 

What Else Do Mortgage Lenders Consider When Reviewing A Mortgage Application?

While your credit score matters, it’s not the only factor mortgage lenders consider. Mortgage lenders also consider your income, down payment, assets, and debts.

Mortgage lenders want you to have a stable income. Ideally, you’re a salaried employee. If not and your income is variable in any way, lenders typically want to see a two-year average. Same goes if you’re self-employed.

For your down payment, lenders want to make sure it’s coming from your own sources. If it’s not, it should be a gift from an immediate family member, such as a parent, sibling or grandparent, and they will likely need to sign a letter confirming that they don’t expect you to repay the gift.

For your assets, the lender wants to make sure you’re not putting every penny towards the down payment. The lender wants to make sure you’ll have some liquid savings after covering the deposit, down payment and closing costs.

Lastly, the lender will consider any debt obligations you have, to make sure you are still able to afford your mortgage payments once you’ve made your regular debt repayments.