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How to Improve Your Financial Health

Have you ever applied for a loan and been declined? Are you thinking of getting a loan or mortgage and not sure if you will qualify? Having a steady source of income is important to qualify for a loan or mortgage, but it’s not the only consideration. This article describes how to improve financial health.

Credit Score, Net Worth, and Debt Servicing are 3 key measures that determine Financial Health.  They also determine whether the bank will lend you money.  I thought it would be a good idea to describe what these terms mean from a bankers perspective and provide a few examples.

Credit Score

Your credit score is represented by a number ranging between 300 – 900 and is based on your repayment history, credit usage, and credit inquiries.  The information from all of your credit cards, loans, mortgages, and any other credit accounts are collected by a credit reporting company such as Equifax or Trans Union.  Anytime you apply for credit, a credit bureau report is obtained to check your credit score.  Loans and credit cards are often instantly approved or declined based on credit score alone. The higher the score the better.

How to Build Your Credit Score

It takes time to build a credit score when you are starting out. Once you have established it, it’s easy to maintain.

  • Start out by getting a student credit card with a small limit if you are in post secondary school.
  • Build your score by borrowing money through loans to purchase tangible assets such as a car, house, or investments.
  • Make all of your payments on time! Set them up automatically so that you are never late.
  • Limit the amount of revolving credit you have, including credit cards and lines of credit. Even if you don’t use the revolving credit, having a high amount of approved revolving credit reduces your credit score.
  • Use your credit cards sparingly! The intention of a credit card should be for convenience or rewards. You should be able to pay the balance off monthly.
  • Pay all of your bills! If you don’t pay your bills they will end up at a collection agency and having a “collection” on your credit bureau will significantly reduce your credit score. This includes phone bills, dental bills, store credit, taxes, pretty much anything you owe.

If you would like more in depth information on credit scores the Debt Canada website is a very detailed resource.

Make sure you check your credit score regularly. Most banks have this option for free right on the online banking app!

Net Worth

This is a number which is derived from adding up all of your assets and subtracting all of your liabilities.  Assets are everything of tangible value that you own, such as your house, car, investments, cash in the bank etc. Liabilities are the balance of any money you owe such as your mortgage amount, car loan, and credit card balances. Your actual net worth and your net worth from a bankers perspective may differ because the bank will record only tangible assets that can be readily valued.  For example, if you have a lot of good jewellery or artwork the bank would not add this into a net worth calculation.  If you have a vehicle that is older than 10 years they would not place a value on that either.

When you are younger and haven’t had time to save or build up net worth it may be low, or even negative.   Ideally, as you age your net worth should increase.

The best book I read when I was young that helped me build my net worth was The Wealthy Barber, by David Chilton. It’s a quick read in a story format so it’s an easy read as well, and you don’t have to know anything about investing or finances to benefit from it.

Net Worth Examples:

AssetsCurrent ValueLiabilities Balance Owing
Savings Account$1500.00Student Loans$10,000.00
Vehicle (15yrs old)0Credit Card500.00
Total Assets $1500.00Total Liabilities $10,500.00
Net Worth (-$9,000)

The above example would be typical of a young student

Assets Current Value Liabilities Balance Owing
House$500,000Mortgage 425,000
Vehicle15,000Vehicle Loan10,000
RRSP Investments 30,000Line of Credit10,000
Savings Account 2,000Credit Card1,000
Total Assets $547,000Total Liabilities $446,000
Net Worth $101,000

Net worth should transition to a positive number with your lifestage

Debt Servicing 

Debt Servicing is a measure of the affordability to make your loan payments, often referred to as Total Debt Service or TDS. It is calculated by adding up all of your monthly payments and dividing that number by your gross (before tax) monthly income.   

Debt Service Example

Liability/description LimitBalance Monthly Payment
Mortgage 
425,0001200.00
Property Taxes

300.00
Heating Costs

100.00
Car Loan
10,000350.00
Credit Card 5,0002,000100.00
Line of credit 20,00010,000300.00
Total Monthly Payments 

2,350.00

In the above example if your gross monthly income is $6000.00 your debt service is 39.2%. (2350/6000).

A few things to note :

If you don’t have a mortgage you would record your monthly rent payment instead and you would not include any amount for property taxes or heating costs.  If you have a condo, the monthly condo payments would need to be included.

The payment amount for credit cards and lines of credit is calculated based on a percentage determined by the bank, not on the minimum payment.  

As a guideline, your debt servicing should not exceed 40%.   

If you are borrowing to purchase a home, there is a second calculation for housing costs called Gross Debt Service (GDS).  This is calculated by adding up your monthly housing costs including your mortgage payment, taxes, heating, and condo fees and dividing by your gross monthly income.  In the example above the GDS is 26.7% (1600.00/6000). The guideline for maximum GDS in Canada is 32%.

Income for Debt Servicing

When calculating debt servicing, your financial institution will only use an amount that represents a steady and consistent source of income. Sources such as commission, bonuses, and overtime will not be considered part of your income unless there is a track record of consistent earnings. So if you got a $10,000 bonus last year, but didn’t receive a bonus the year before, this would not be considered in the income calculation. Typically a 2-3 year average is used for these additional types of income.

In a nutshell, healthy finances look like this:

High Credit Score – 650+

High Net Worth – there is no magic number here, the higher the better and it should not be negative unless you are just starting out.

Low Debt Service – below 40%

I welcome your comments and questions, and please share this if you have found the information helpful.

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