Credit Score
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A credit score is a rating used by money lenders to rate how likely, and quickly, you are to pay the debt back.
Whenever you get anything with credit (credit card, line of credit, mortgage, etc.) you will automatically begin having a credit score. This score tells you your ability to get loans and helps decide what interest rates you get on those loans.
In Canada, your credit score ranges from 300 to 900.
- 900 is a perfect score
- 780-900 is an excellent score
- 720-780 is a strong score
- 680-720 is an fair score
- 625-680 is below average score
- 300-625 is a low score
When you have a low score (300-625) it will be harder to get a loan. You can still get some loans with a low score, but they will have higher interest rates.
To check your credit score, most banks offer one free credit score check each year. After that you will have to pay a small fee to check your score. You can also visit TransUnion or Equifax and get a credit score check for a small fee.
How is a credit score calculated?
Your credit score is calculated from five factors:
- Payment history (35%)
- Amount you owe (30%)
- Credit history (15%)
- How often you apply for credit (10%)
- What kinds of credit you have (10%)
1. Payment history (35%)
Most important factor for your credit score. Lenders obviously want to know if you will pay them back.
Lenders want to know:
- Do you pay your bills on time?
- How often do you miss a payment?
- How many times have you missed a payment?
- How long ago did you miss your payments?
2. Amount you owe (30%)
How much you currently owe in loans will tell lenders if its good to lend you money. Lenders want to know if you are able to get more debt and still pay it back.
Lenders want to know:
- How much in total do you currently owe?
- How much are your payments?
- How much of your available credit do you use on an ongoing basis?
3. Credit history (15%)
Lenders want to see a long history of having and using credit. There’s nothing scarier to them than someone first getting credit (as they dont know if they can pay it back). A good credit history is built over time.
Most banks only look at the past 7-8 years of your credit history. So if you had bad debt, or went bankrupt, 9+ years ago then that will not affect your current credit score (in most cases).
Lenders want to know:
- How long has it been since you first obtained credit?
- How long you’ve had each credit account for?
- Are you actively using credit now?
4. How often you apply for credit (10%)
Applying for a lot of different loans tells lenders that you may have trouble with your money. If you often sign up for new credit cards, loans, or other forms of credit lenders may think that you're not able to pay back your loans.
Lenders want to know:
- How many times did you request a credit check in the last 5 years?
- How many credit accounts have you opened recently?
- How much time has passed since you last opened a new account?
- How long ago did you ask to check your credit?
5. What kinds of credit you have (10%)
The kinds of credit you use says a lot about how you handle your money. There are 2 kinds of credit: revolving credit (where you have a credit limit but can pay if off and use it again like credit cards) and installment credit (where you pay back a part of it once a month, bi-weekly, etc. like in a mortgage). Having high levels of revolving credit is better for your credit score than having high levels of installment credit.
Lenders want to know:
- Do you have high levels of revolving credit?
- Do you use deferred interest or payment plans to pay for large purchases?
- Do you resort to loan consolidation services?
- Do you access payday loans or other unsecured loans?
How to improve credit score
1. Make regular payments
The easiest ways to improve your credit score is to regularly pay off your debt. These are things that lenders love to see: consistency, dependability, regularity and history.
When it comes to credit cards, the best financial advice is always to pay it off every month (or twice a month) so you’re never building debt.
The Financial Consumer Agency of Canada recommends using less than 35% of your credit limit.
2. Close your newer accounts
If you have several credit cards and you’re thinking about closing one (or a few) of them to help you pay off your debt, it's better for your credit score to choose the credit card you got most recently (unless the older one has higher interest rates).
Canceling a credit card will always have an immediate negative impact on your credit score because you are reducing the amount of available credit (increasing your debt utilization ratio). Long term though, it will help.
3. Accept an increase on your credit limit
Increasing your credit limit can also help your credit score (as it increases your debt utilization ratio). Credit card companies will often offer their customers a bigger limit if you are paying off your debts regularly.
Just be careful you're not getting into more debt to try and improve your credit score.
4. Use different kinds of credit
Remember that revolving credit is considered to be less secure than installment credit, so revolving credit will give you a better credit score than installment credit will.
If you are just starting out with no credit, an RRSP loan is one of the best things for you to improve your credit score. It helps you build a great credit history (through installment credit) while boosting your RRSP savings.
5. Go see a banker or financial advisor
If you have the time and money, you can go talk to someone at your bank or a financial advisor. For a small fee they will help you come up with plans to reduce your debt and increase your credit score.
