There is a misconception that good credit rating guarantees a person an approval for a loan or credit. There are three basic requirements a bank is looking for an applicant to qualify for a loan or credit. These are commonly called, the “three Cs of credit”. These are good Credit Rating, Capacity to pay, and sufficient Collateral.
Good credit rating means you are on time in paying your monthly obligations: these are reflected in your credit bureau file. Capacity to pay means you have a permanent (at least two years) good paying job. Collateral is a personal or real estate property with sufficient value to secure payment of your debts. In the event you default on your payments, a lender could seize the subject property and sell it to pay for your debt. However, a lender may waive a collateral if the amount of loan or credit is relatively small, example: credit cards.
The three Cs of credit work this way: If a person applies for a loan with a good credit rating but he/she has unstable job, a lender would decline her/his credit application; similarly, if a person has a stable job but with bad credit rating, a lender would disapprove his/her application; likewise, if a person has a good credit rating and stable income, but there is no sufficient collateral, a lender would reject her/his application.
Furthermore, although a person meets the three Cs of credit a lender may still decline a credit application if the applicant is loaded with debts that his/her income is not enough to pay the monthly payments (high Debt Service Ratios).
Knowing that good credit rating alone could not help someone to secure a loan or credit, it is unwise for a person who is loaded with debts and has a high Debt Service Ratio to juggle his/her credit cards or borrow money from friends and relatives just to pay minimum monthly payments to creditors to maintain a good credit rating. There are two reasons why it does make sense: first, the minimum monthly payments are practically applied only to interest only - the debts could never be extinguished or paid in full even after retirement or death of the debtor; second, good credit rating alone does not qualify him/her for a loan or credit – it does not serve any good purpose.
If you are loaded with debts and you are obsessed of maintaining your good credit despite your inability of securing a loan or credit, maybe it is time for you to evaluate your financial situation and focus on settling or wiping out your debts first, and reestablish your credit rating later.
To manage your debt problem, you may consider the following options: credit counseling, consumer proposal, or bankruptcy as your last resort depending on your financial circumstances.
It is nice to maintain good credit rating, for it could enable you to secure credit when you need it, provided you have met the other two requirements (capacity and collateral) and you are not loaded with debts. Otherwise, it is your financial burden for life, for good credit rating alone does guarantee you can secure loan or credit.
Adam Aspilla is a Senior Financial Counselor of the Debt Clinic of Canada Inc. and the author of the book, You Can Negotiate All Your Debts. He also writes a biweekly column, “What Matters In Life” in “Taliba Newspaper. For free initial, professional and confidential consultation, please call 905-306-7572.