Mike's Spruce Grove Mortgage Blog

Credit education in our Schools Wednesday, May 1, 2019
Credit Education in our Schools

Soap box time...

The most financially influential score of your life is your credit bureau risk analysis score.  You would think that there would be some kind of mandated high school course that helps guide us through the real life credit jungle.  Your high school grades may get you into college and they might get you a better starting salary, but your FICO score helps determine your interest rate or worse, whether you even get your mortgage. 

It is very evident that most of us are trying to educate ourselves the best way we know how...on the internet. Basic credit education should have been taught to you as a life skills course, so that you didn't have to learn from your first second and third bad credit experience.

In a personal experience, after I graduated high school (just over 40 years ago), I took out a car loan at a local credit union. A few months later, I wanted a newer car, so I sold the car (for cash) and went in to pay off some of the loan.  I was about to get a little lesson in loan collateral.  The credit union had used my vehicle for security on the loan and I wanted to use some of the cash for a down payment on the new vehicle.  I asked them what would have happened if I had not used the cash to repay the car loan and they told me that they would have called in the loan.  They also told me that whoever bought the car with cash might have lost the vehicle to a repossession, if the loan was not resolved.  Loans officers are not educators.  Most of them do their job and lend the money.  Many people are not as lucky and learn their credit knowledge from the school of hard knocks.  That means they pay large interest rates to finance companies and payday loan companies, because they screwed up early and the banks won't lend to them.  Buying a home, at a decent rate, is something they can only dream about, without a cosigner.

Do you recognize yourself doing any of these kind of innocent mistakes...

  • making a large payment on your credit card (thinking it will pre-pay your next few months).
  • after your roommate fails to pay the phone bill you gave him money to pay, you simply blame him for the unpaid bill.
  • The car is a lemon, so if I don't pay for it they can come and get it.
  • You get the picture...innocent enough but they could have been handled different.

What this does is create a rating that does not disappear for 7 years on your credit bureau. Every bank you apply to will be asking the same questions, every time you apply...totally avoidable if you knew the real consequenses. Inactive credit, even inactive collections will not affect your Beacon score after 2 years of remaining dormant, but the bank will still see them and question them until their 7 years is up. 
How do I prepare for the bank application credit test?  Relax, there is no test, but here is what the bank grades you on before they lend you their money. So you might be able to plan in advance.

6 C's of credit

Credit:  The banks look at... How you paid your bills. Any late payments, how long your credit is established, how large your credit limits are, how much you owe against your credit limits. Any collections or judgments against you or bankruptcy type history (Orderly payment of debt, consumer proposal etc).

Character:  How solid is your career? How often do you change jobs or residence? Whenever they can, a bank will interview landlords, employers and yourself to see if you are compatible to their lending criteria.  Banks also have a "Know your customer" policy, so if you are established with a chequing or savings long enough and get to know the people at your branch, it helps to establish a credit trust rapport.

Capacity:  How much do you make?  Can you afford the repayment of the loan? You might think you make enough money, but the bank has a formula that they calculate your Total Debt Service capacity. Your credit and Character might be fine, but if you don't meet this calculation, you are still not going to qualify.

Conditions:  What are the circumstances of your deal?  Are you borrowing to get ahead...for things like your RRSP, purchase a home, renovating, purchase a car, leverage for another investment.  Or are you borrowing to shore up your credit, for things like lowering your payments, paying off taxes, paying out collects.  The banks look more favourably at your application if it is for a positive purpose.

Collateral: This would be the quality of the bank's security. If you are buying a home, is it in a good neighbourhood etc.?
If you are buying a car/truck, they type of vehicle will determine the length of time the bank will finance the vehicle (affecting the monthly payment).  A new vehicle can be financed longer.

Capital:  This is a little known item that will affect your borrowing decision every time.  If you have Liquidity, the bank will take your application more seriously.  Liquidity is available money (savings, chequing, RRSPs, Shares, Stocks, Bonds, Inheritance, cash gift from parents. etc)  and Capital=Money is KING! If you have available money the lending officer knows you have the ability to make your loan payments and your lending officer knows you have demonstrated the discipline to save.

I'll get off my soapbox now, but I hope this helps you to better understand the world of credit, that you should have been taught  before you were sent out into the real world.

posted by MIke Toporowsky at 12:57 pm

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