A key determinant of your creditworthiness and financial stability is your credit score. Lenders significantly rely on this three-digit number to determine the risk involved in giving you money when applying for a mortgage. A better credit score shows the lender that you are a lower risk, and it may have a big influence on your Loan-to-Value (LTV) ratio. This ratio calculates how much of the loan amount is compared to the property’s appraised worth. In this article, we will discuss the complex link between your credit score, LTV ratio, and mortgage rates.
Defining the credit score and how it’s calculated
Your credit score is a numerical representation of your creditworthiness, serving as a summary of your credit history. It considers various factors related to your credit history. These factors include your payment history, credit utilization, length of credit history, credit mix, the amount you owe, recent credit behaviour, and your available credit. The most commonly used credit scoring model is the FICO Score which is used by 90% of Canadian lenders. They crunch these various factors and generate your credit score. Let’s look at these factors:
- Payment history: Do you pay your bills on time or have a habit of procrastinating? Your payment history will show lenders if you’re responsible and reliable when it comes to meeting your financial obligations. A history of late payments or defaults is not a good sign.
- Credit utilization: This factor examines how much of your available credit you are currently using. Are you maxing out your credit cards, or do you keep your balances low? Lenders prefer borrowers who demonstrate discipline by keeping their credit utilization ratio at a reasonable level, rather than constantly being on the edge of their credit limits.
- Credit mix: Examines the types of credit accounts you have, such as credit cards, loans, and mortgages. A diverse credit mix can be seen as a positive sign, showcasing your ability to handle different types of credit responsibly.
- The amount you owe: The amount of the most recent reported balances on your credit accounts is referred to as your account balances. If at all feasible, try to pay off all of your bills each month to keep your debt low and demonstrate to lenders that you can make timely payments.
- The length of your credit history: Lenders like to see a long, well-established credit history as it provides them with more data to evaluate your creditworthiness. If you’re just starting on your credit journey, don’t worry; time will help your credit score.
- Recent credit behaviour: When you apply for new credit, lenders may perform inquiries on your credit report. Too many inquiries within a short period can raise eyebrows and affect your credit score.
The exact calculations and weight given to each factor can vary between credit scoring models. However, the general principle remains the same – the higher the score, the more appealing you are to lenders.
Does a low credit score affect my loan-to-value (LTV) ratio?
Lenders examine your creditworthiness and the risks of granting you money when you apply for a mortgage. Your credit score is a major factor in this assessment because a low score may make lenders question your capacity to handle your financial responsibilities and may make you seem like a riskier investment.
The LTV ratio, on the other hand, is a straightforward mathematical formula that contrasts the loan amount and the property’s appraised worth. It aids lenders in estimating their exposure should you stop making your mortgage payments. A greater LTV ratio denotes a larger loan amount in relation to the property’s worth.
This is when having a poor credit score becomes important. Traditional lenders will often reject you outright for having a low credit score. A borrower might need to seek a loan from a higher risk private lender. Private mortgage lenders require at least 25% down-payment for new purchases.
The relationship between credit score and your mortgage interest rate
Your credit score plays a big role in determining the interest rate on your mortgage. Since lenders use risk-based pricing, borrowers with stronger credit ratings are eligible for lower interest rates. A higher credit score demonstrates that you have a good credit history and are an accountable borrower, which appeals to creditors more. On the other hand, the perceived danger associated with a poor credit score will cause lenders to impose higher interest rates.
How can your credit score be improved to get a better LTV and lower interest rate?
Improving your credit score takes time and effort. But doing so can significantly impact your LTV ratio and mortgage interest rates. Start by ensuring that you pay your bills promptly, as your payment history is a crucial factor in your credit score calculation. Reduce your credit card balances and maintain a low credit utilization ratio. Avoid opening multiple new credit accounts within a short period, as this can negatively affect your credit score. Regularly monitor your credit report for errors and dispute any inaccuracies promptly. Building a solid credit history over time will enhance your credit score and improve your prospects for a better LTV ratio and lower interest rates.
Is it possible to get a mortgage with a low credit score and a high LTV ratio?
It’s certainly more challenging but not impossible, several options are available for borrowers in such situations. The Canada Mortgage and Housing Corporation, for example, assists borrowers with lower down payments and higher LTV ratios. They do this by providing mortgage insurance to lenders. This, in turn, reduces the risk of issuing mortgages to home buyers. It is crucial to explore different lenders and loan programs to find options that cater to your specific circumstances. Working with a knowledgeable mortgage professional from Mortgage Broker Store can help you navigate the process and find solutions that suit your needs. So if you need assistance, don’t hesitate to contact us via email at ron@mortgagebrokerstore.com or phone (416-499-2122).
