A first-time homebuyer’s guide to building a healthy credit history for homeownership
Spotty credit card payments might not seem like a big deal when you’re first starting out, but that banking boomerang will hit you hard when it comes back around during that first home purchase.
If you have an icky credit history, or outstanding consumer debt, you’re not alone. For every dollar of disposable income, Canadians owe roughly $1.78 to creditors, according to a recent Angus Reid survey. Canadians are notorious for having high levels of consumer debt, with 59 percent of those in debt having the majority of it on their credit card. Financial ignorance or simple credit confusion can often be to blame for the misuse of credit cards.
“There are so many myths out there about credit that really need to be debunked. I hear them all the time when I do workshops,” says Jessica Moorhouse, a financial counselor and award-winning Millennial money blogger, in a statement to Livabl.
While a 2018 Public Policy Forum report found that money management literacy is doing well among younger generations, it’s important to establish healthy credit habits long before homeownership occurs. A credit history riddled with mistakes, or no credit history at all, can be a major impediment to getting pre-approved for a mortgage loan.
“If you don’t have any credit history and you’ve only got a small down payment, you could be declined based on the fact that there is no credit history,” says Laurie Campbell, CEO of Credit Canada Debt Solutions. “They don’t really know how you’re going to manage that debt.”
If you’ve got crummy credit history, don’t panic — you can turn it around. We asked Campbell and Moorhouse for their do’s and don’ts for buyers looking to build a solid credit history in advance of their first home purchase.
DON’T: Spend to infinity on your Affinity
A high credit limit may tempt you into loading up on your card, but you should always exercise restraint.
“Never go over your credit card limit or max it out every month,” says Moorhouse. “Typically, you should only be using 20 to 30 percent of your credit limit. If you tend to spend close to your credit limit every month, consider raising your limit.”
When you become a homeowner, it’s important to keep the same philosophy in mind. If you overspend on a mortgage without considering the additional expenses of sudden repairs, insurance and maintenance, you may find yourself house poor. This vulnerability can make credit cards seem like a viable source of financial relief.
“If you’re house poor, it’s easy to start using credit cards as a crutch because you can’t meet your obligations,” says Campbell.
To leave some financial wiggle room, Campbell recommends growing as high a down payment as possible and to avoid borrowing the maximum mortgage loan you’ll be approved for from lenders.
DO: Pass on extra plastic
If you have multiple credit cards, that means the bank believes you’re a trustworthy borrower, right? Wrong. Instead, you could be sending the wrong message to future lenders.
“Having too many credit cards may signal to creditors that you have a limited capacity and may not be able to afford to pay any new debts back on time,” says Moorhouse. “It may also be too tempting to overspend with too many cards on hand.”
Moorhouse recommends sticking with one to three credit cards. Campbell says just one card can be enough to prove you’re savvy with paying back your balances.
“One good, solid credit card with two or three years of consistent payments — you’re always on time, there’s no late payments — it shows that you are in control, that you’re paying as agreed,” she says.
You may also want to pass on a line of credit unless you really need it. Moorhouse often hears that lines of credit are pushed as a ‘must have’ for financial emergencies, but she sees little benefit in them for improving your credit score.
“A line of credit can serve as a great tool when you need credit and don’t want to pay the high interest rate of a credit card,” she says. “However, it’s not necessary to have even though the banks love to tell you otherwise. I’ve never had a line of credit, I’m a homeowner, I’ve got a high credit score.”
DO: Swallow the pill and pay your bill — all of it
If you think paying off last month’s $60 bar tab charge can wait, think again. Moorhouse and Campbell preach paying off your card, in full, every month. If left unmonitored, payment due dates can easily sneak by unnoticed.
“You might think it’s very innocuous and it doesn’t mean anything, but it absolutely does,” says Campbell. “Make sure you pay it off every single month. Don’t assume that you can miss a payment here or there because your balance is not that big. It doesn’t work that way.”
Doing the opposite and keeping a negative balance— overpaying on your bill or getting a payment credit after you already paid — will not undo the wrongs of missed payments or boost your credit score. Instead, Moorhouse says it can cause further damage. She recommends regularly paying off charges.
“The key things to know is if you’re using credit cards, pay them off in full every month,” she says. “Better yet, pay off your balance every day or after every purchase so you’re never left with a big bill and no idea what happened.”
DON’T: Run and hide from credit
If you have student debt, or are cautious about using credit, it might seem like a good strategy to avoid credit card use altogether. This will only come back to haunt you when future lenders assess your creditworthiness. With no credit history, there’s no proof in your ability to make payments.
“The only way, or best way, to establish credit, is to borrow and pay back. Just getting a credit card and letting it sit is not going to build your credit rating,” says Campbell. “You need to use that card and show your payment history, that you’re capable, as agreed, of paying it every month over a period of time.”
A good credit history can reward you with low interest rates. A poor history, or a non-existent one, could result in difficulty being approved for other kinds of credit and at higher interest rates.
“In lots of those cases, when people really need credit, that’s when they go for those expensive loans or payday loans because they feel like they have no other choice,” says Moorhouse. “And that’s definitely not a trap you want to get caught in, because it is very difficult to climb your way out of expensive loans.”
To keep tabs on your credit history, Campbell recommends prospective buyers check their credit report once a year with monitors such as Equifax or Transunion.
DON’T: Ghost on your credit card statement
Even with plenty of online tracking resources at their fingertips, Campbell says she encounters clients with no knowledge of their current credit situation.
“It’s really crazy that some people come in and say they don’t know what’s on their credit card. They don’t open their statements,” she says. “Look online. Be aware of where you’re at. I think it’s imperative to really have a feel for your full financial situation.”
About once a year, Moorhouse recommends running a credit report to verify your score and credit health. Keeping up to date is a surefire way to flag and report any inaccuracies to credit bureaus. Use online banking to regularly monitor incoming charges and payments. This way, you’ll always know what to expect on your next statement.