If you know anything about loans and borrowing money, then you know how vital a role your credit score plays in lending decisions that banks and credit unions make. You may think that if your credit score is too low, you will be told that you cannot get a bank mortgage with bad credit. You may also have heard that it is hard to qualify for any loan – and if you do qualify, that your interest rates and fees will go through the roof. Let’s take a closer look at your credit score and how it can impact the interest you will pay on loans – mortgages and other types as well.
Your credit score, sometimes known as your FICO score, is a number between 300 and 850 that is calculated from five factors: amount you owe, payment history, new credit, length of credit history, and credit mix. The amount you owe is worth 30% of your credit score and reflects the amount of your current debt compared to the available credit you have. If you commonly hit your credit limit or stay near it, lenders will assume that a loan is risky because you frequently spend up to or even past your credit limit.
Your payment history (35%) reflects how often you make payments on time for your obligations. Factors such as delinquencies, accounts in collection and any bankruptcies play a role here. The more your credit history lists issues with payments, the lower your credit score will drop.
New credit (10%) and credit mix (10%) refer to the makeup of your debt. When you apply for new forms of credit, such as new credit cards, a new car loan, or other type of debt, the assumption is that you are suffering from financial pressure, so your credit score will dip a bit. This is why loan officers will often tell you not to apply for any new credit between the time you make a loan application, and the lender responds with a decision – your credit score will drop, and if you’re right on the line of eligibility as it is, that can harm your chances of closing. Credit mix means that you have both installment credit in the form of a car loan or mortgage (or a student loan) and revolving credit, such as credit card, lines of credit, and/or retail store and gas station cards. A diverse credit mix gets you a slightly higher score.
Length of credit history (15%)
Accounts that stay open and remain in good standing help your credit score over time. Even if you have been perfect in your payment history for the last two years, if that’s as old as your credit gets, you won’t have as high a score as someone who’s had a perfect payment record for a decade. It just takes time to build this part of your score.
Credit Card Rates
Different credit card issuers have different target markets and different credit offerings. Some banks focus on the bad credit loans Alberta and other province residents needs, while other banks only offer cards to borrowers with high credit scores. The more of a credit risk you are to a bank, the higher your rate will be. Some cards in Canada are available at a 0 per cent introductory offer before transitioning to a permanent rate, but if you have a lower score, you could start out with interest rates between 10 and 20 per cent.
When you apply for a credit card, you’ll want to focus on the APR, or annual percentage rate. That is what the credit will cost you if you don’t pay the full balance each month. If you do pay the full balance, you won’t owe any interest, so the rate doesn’t matter. If you do fail to pay off your balance, though, the interest can add up over time.
If you have a credit score of 720 or higher, then you’ll face the lowest effective interest rate, which is the amount of interest you are charged per year divided by the total balance you owe at the end of a cycle. According to a study by the U.S. Consumer Financial Protection Bureau (CFPB), if your credit score is below 580, you’ll pay an effective interest rate about 8.5 per cent higher than those borrowers with scores above 720. So, if your credit score is low, a credit card is an expensive option if you’re not going to pay the balance each month.
Personal Loan Interest Rates
At this writing, the Canadian Imperial Bank of Commerce (CIBC) offers personal loans with terms of one to five years starting at a prime rate of 7.20 per cent. The rate available to each borrower will vary based on several factors, including credit score. Offering a personal loan without any collateral involves greater risk than a mortgage or other secured loan, which means that the interest rate will be higher. This sort of credit has a lower interest rate than a credit card does, but people with lower credit scores often have a more difficult time securing approval through traditional lenders. If you end up needing the type of bad credit loans Alberta and other provinces have available through corporate and other lending institutions, you may want to consider a private mortgage, depending on your specific needs – more on those below.
Even if you end up with the sort of bad credit mortgage Canada lenders offer, your interest rate is almost certain to be lower than what you would get with a credit card because the loan is secured by the real estate it was used to purchase. When you’re talking about a mortgage on your primary resident, even a mortgage with bad credit, your interest rate will reflect the fact that borrowers will almost always sacrifice every other loan to avoid foreclosure.
In Canada, most traditional lenders require a credit score of 680 or higher to approve a mortgage. Some traditional lenders may be willing to go lower, but then you’re looking at significantly higher interest rates and other terms and fees that you may find less than desirable. If your credit score is lower than that, then you’re looking for the kind of bad credit mortgage Canada generally sees end up in the hands of private lenders. The good news about private lenders is that they design their loans to help borrowers qualify for traditional financing at the end of the term. Private mortgages generally have terms of less than a year, or no more than two years. In some cases, borrowers can make payments on just the interest of the loan, with the assumption that at the end of the term, the borrower will be able to move the debt to a traditional loan after having used the term of the private loan to repair his or her credit score.
One problem with credit scores is that the same number can mean two very different situations for two different borrowers. When people ask us, “What are private mortgage lenders?” we tell them about a network of individuals and businesses that look to help borrowers who have the means to satisfy their financial obligations but don’t have the credit score to gain approval from traditional lenders. Going through a messy divorce that involves splitting debts, enduring a layoff, dealing with a long-term illness, and other situations can lower credit scores even though the people going through those situations have the means to pay for a mortgage. Private lenders also look at your credit score as part of the application process, but they give more weight to the value of the property that will secure the mortgage than traditional lenders do. Because of the elevated risk of private loans, a forced sale is more likely – which means that the lenders have a greater chance of having to get their money back from the proceeds of that type of sale.
It’s important to take a careful look at your financial profile before taking on the burden of a mortgage. While you may find that the cost of renting is comparable to what you would find with a mortgage, remember that owning a property also involves responsibility for any repairs that pop up. Renting for another year or two until you have some emergency savings in the bank might be the best bet for you. If you have a financial cushion in place, though, and are just dealing with the aftermath of some damage to your credit score, a private mortgage might be the best option for you.
Amansad Financial works with borrowers dealing with these issues, linking them with private lenders. The mortgages provided are funded by the following (as referenced on https://amansadfinancial.com/common-private-lending-questions/ (Q&A-9):
- Amansad Direct Lending Group’s network of Individual Private Lenders (IPLs)
- MIC (Mortgage Investment Corporation) & MIE (Mortgage Investment Entities) Partners
- Amansad Direct Lending Group Approved syndicated Private Lender Groups