Credit and Mortgage Financing: Understanding the Basics

Buying a property is a significant investment, and for most people, it means taking out a mortgage. But before you can even think about obtaining a mortgage, you need to have a good history of managing your credit. In this article, we'll explore the basics of credit and mortgage financing, including what lenders look for in a credit report and how to establish a good credit history.

What is Credit?

Credit is the ability of a customer to obtain goods or services before payment based on the trust that they will make payments in the future. When you borrow money to buy a property, lenders will assess your credit report to ensure that you have a good history of managing your credit. This means making payments on time and not defaulting on any loans or credit cards.

What is a Good History of Managing Credit?

Lenders look at various factors when assessing your credit report. If you're new to managing your credit, the 2/2/2 rule is an easy way to remember the minimum credit requirements for mortgage financing. This rule stipulates that you need to have two active trade lines established over a minimum period of two years, with a minimum limit of two thousand dollars.

A trade line is any time a lender extends credit to you, such as a credit card, an instalment loan, a car loan, or a line of credit. Your repayment history is kept on your credit report and generates a credit score. To be considered active, a trade line must have been used for at least one month and then once every three months.

To build a good credit history, both of your trade lines need to have been used for at least two years. This history gives the lender confidence that you've established good credit habits over a decent length of time.

Two thousand dollars is the bare minimum limit required on your trade lines. Suppose you have a credit card with a $1000 limit and a line of credit with a $2500 limit. In that case, you would be okay, as your limit would be $3500. If you're managing your credit well, chances are you will be offered a limit increase. It's a good idea to take it as mortgage lenders want to know that you can handle borrowing money.

It's important to note that you don't have to carry a balance on your trade lines for them to be considered active. To build credit, it's best to use your trade lines but pay them off in full every month in the case of credit cards and make all your loan payments on time.

How to Use Your Credit Effectively

A great way to use your credit is to pay your bills via direct withdrawal from your credit card, then set up a regular transfer from your bank account to pay off the credit card in full every month. Automation becomes your best friend. Just make sure you keep on top of your banking to ensure everything works as it should.

Your Credit Score

Your credit score is a numerical representation of your credit history. It ranges from 300 to 850, with higher scores indicating that you're a more reliable borrower. Lenders use your credit score to determine your creditworthiness and the interest rate you'll pay on your mortgage.

While your credit score is important, if you have two trade lines reporting for two years with a minimum limit of two thousand dollars without missing any payments, your credit score will take care of itself, and you should have no worries.

Checking Your Credit Report

It's a good idea to check your credit report every once in a while to ensure that no errors are reported on your credit bureau. You're entitled to one free credit report per year from each of the three credit bureaus, TransUnion, Experian, and Equifax. Review your credit report carefully to ensure that all the information is correct.