In our recent article Credit and Credit Scores in Canada: What You Need to Know, we talked briefly about credit (borrowing money from a financial institution) but spent most of our time discussing credit scores and their role in Canadian life. So, let’s take a closer look at credit in Canada.
To recap, credit is the privilege of borrowing money from a financial institution (or lender) based on the understanding that you (the borrower or debtor) will repay the money at an agreed upon date and rate of interest. You may also utilize credit to make a purchase now with the agreement that you will pay later. This can come in the form of credit cards, retail credit and personal loans.
The most significant kind of personal credit is a mortgage. Very few people can afford to buy a property outright, and so they must borrow a significant portion of the dollar value from their bank. In Canada, new home buyers are required to have a down payment of 20%, so the mortgage loan must cover the rest of the price of the home. Buying a home is a daunting task in and of itself – getting approved for a mortgage can be very stressful.
Banks take a number of factors into consideration before deciding on a borrower’s credit worthiness and approving a loan. Although demonstrating you have the ability to repay the loan is crucial, your credit is measured using the five C’s of credit.
The 5 Cs of Credit in Canada: Character, Capital, Capacity, Collateral and Credit
- Character describes (in the eyes of the lender) the kind of person you are when it comes to finances. Factors ranging from your credit history, length of employment, your propensity to save and whether you utilize credit responsibly all inform your character and trustworthiness to repay loans. Here are a few questions a lender may ask to determine if you are a reliable borrower:
- How long have you been at your present job?
- How long have you lived at your present address?
- Do you pay your bills on time?
- Have you used credit before?
- Do you have a good credit report?
- Can you provide character references?
- Capital refers to those things you own (assets), such as a home, an automobile, or savings and investments. The lender is interested in these as ways to or secure the loan (repay the debt you owe) in the event that you fail to make your payments.
- Capacity is your ability to repay loans. Arguably the most important of the C’s, your capacity to pay back is calculated based on your job and annual income as well as payment history. You may be asked these questions by a lender:
- Are you employed with a steady job?
- What is your salary?
- How many dependents do you have?
- What are your current expenses?
- Do you have other loan payments?
- If so, how may?
- What are your current debts?
- Collateral adds up to additional security for the bank. The value of the house or condominium you are borrowing money to purchase, based on its value, location and characteristics is considered collateral. Collateral can also include outside parties who are willing to guarantee the loan.
- Credit in this context, refers to your repayment history. This is the one clear way a lender can predict the likelihood of you reliably making future payments. The primary measurement used is the credit score – also known as credit history, credit report, credit rating.
Even if you’re not ready to buy a house, it is important to understand the Canadian financial landscape and how to prepare, budget and plan, especially when it comes to Credit.
5 tips on how to maintain a good credit rating
- Pay your bills on time. Contact your creditors if you are unable to make a payment.
- Pay off debt quickly, and when you can, pay more than the minimum amount.
- Understand the total cost of the things you purchase, including interest charges.
- Never sign a contract until you have read it and understand it fully.
- Only deal with established, reputable financial companies.
At Arrive, we are dedicated to helping newcomers achieve career, life and financial success in Canada. As part of our focus on the financial side of your journey, we are sharing financial tips and information in our weekly blogs, providing handy online tools and hosting highly-informative webinars and workshops.
To learn more, view our webinar The Importance of Building Good Credit in Canada.
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This article offers general information only and is not intended as legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. While information presented is believed to be factual and current, its accuracy is not guaranteed and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author(s) as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or its affiliates.