Rebuilding Your Credit
Think of it as a Process:
It took you a while to get into debt, and it took you some time to get out of debt, so regaining access to debt will also take time. The steps suggested below should help to prepare you to be eligible for debt, help clean up your credit report and generally improve your credit rating.
Take stock of where you are at financially – if you have no job or no reliable, regular, income get that sorted out first. Most creditors will not lend to people who have low or no income and no hope of making payments on their debts.
Obtain copies of your credit reports from both Equifax and Trans Union – they are the two largest credit reporting agencies in Canada.
Carefully check each of your credit reports for any errors and/or omissions.
Send each agency a copy of your discharge certificate along with information regarding any errors you may have found on your report. This may be as simple as providing a copy of a birth certificate or more complex, such as proving that a debt was paid out, depending on the error.
Think of there as being three main tiers of lenders, top tier of course being chartered banks followed by finance companies and store credit card lenders and at the bottom we might add payday loan companies as well as some in-house financiers and others that bear extremely high interest.
Credit from top tiered lenders is generally less available to people with bad credit reports than it is from the lower tiers. Nonetheless, you will get more credibility and higher credit scores from having institutional (top tiered) lenders on your credit report than payday loan or finance companies.
It is easier to borrow money when you have assets. Some lenders may want to secure their loans with your assets. This can be good from a short term borrowing perspective but your credit score would be higher if you are managing unsecured debt as opposed to secured debt.
Take some time following your discharge to rebuild your assets, make regular contributions to an RSP or TFSA. Rebuild RESPs and work on paying down your mortgage. You may be able to leverage some of your assets to help you get started again.
If you are contemplating a secured credit card to re-establish credit make sure that its use will be reported to the credit bureau – some may not report. Bear in mind that some banks and credit unions may offer secured credit cards, if yours does, even if the interest rate is a bit higher, they may provide a quicker conversion to an unsecured card in the future.
Debt Service Ratios:
Lenders use debt service ratios to determine how much debt you can carry before you are over leveraged. A Total Debt Service (“TDS”) ratio usually doesn’t exceed about 42% – although that value varies between lenders. A TDS at 42% assumes that you can afford to pay up to 42% of your gross income managing debt, so for example:
Bob’s monthly payments are $2,225 for a mortgage, $1,000 for a school loan, $350 for a motorcycle loan and $650 for a credit card balance, totaling $4,225. ($2,225 + $1,000 + $350 + $650 = $4,225.) Bob works as a salesman and his gross monthly income is $11,000. Therefore, Bob’s TDS ratio is approximately 38% ($4,225/$11,000 x 100 = 38.4).
In that example Bob can still use up to 4% of his gross income to manage more debt. In other words, if Bob’s payments do not exceed $440 (4% of his gross income) per month the new debt would be “affordable” using that ratio. But if Bob wanted to apply for credit that would require a monthly payment of $500 his application would likely be rejected.
Applying for Credit:
Applying for credit will affect your credit score, the more you apply and the more you get rejected the worse your credit score will become. Only apply after you have a stable income and after you have updated the credit reporting agencies.
Leverage your assets with top tier lenders – offer to put up a GIC or RSP as security for a credit card or small line of credit. Some furniture stores will lend you money to purchase their furniture, the interest rates are usually high and the furniture is sometimes taken as security. Such loans will help improve your credit score but not as much as institutional credit. Try second tier credit cards to get started, they are usually easier to get than bank issued credit cards.
Some of these things are counterintuitive but if followed should help to improve your credit score.
- Do not make lots of applications for credit – especially if you are declined, too many hits on your report will lower your score.
- Do not max out your available credit, always leave some room, people who max out their available credit are a higher risk to lenders.
- Make more than minimum monthly payments, making only minimum payments suggests you are having problems managing your debts.
- Do not pay the full balances off each month – remember the lenders want to see how well you can manage to carry debt on a month by month basis, develop a history.
- If you obtained payday loans during your insolvency that may hurt your ability to access credit in the future, even if you paid them back.
The Two Twos:
Most of the mortgage brokers/agents we have spoken with have advised that they want to see you discharged (proposal completed) for two years and with two institutional lenders on your credit bureau report before you will be eligible for a new mortgage with an institutional lender.
Nonetheless, mortgages are available to anyone able to sufficiently mitigate the risks to the lender. The two most common ways to reduce risk are by having cosigners or putting up a significant down payment.
Above all else, remember re-establishing credit is a process, don’t rush, expect it to take a year or two.
Call us for more information and insights: 519-646-2222