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What is a credit score
Your credit score is like your public financial scorecard that is used by people and companies to not only determine if you are worthy for loans and credit cards, but to determine what interest rates they will charge you for those loans and credit.
What Affects Your Credit Score
Payment history – 35%
Utilization ratio – 30%
Credit history – 15%
Credit inquiries – 10%
Public records / variety of credit – 10%
How to Improve Your Credit Score
Pay your bills on time
Lower your utilization ratio
Get a diverse set of credit
Check your score annually – you want to make sure there are no errors
How to Build Your Credit Score
Apply for a credit card
Make purchases through that card – but keep it minimal to keep utilization ratio low
Pay the bill off in full each month – builds history of constant payment
Pay your own phone bill – increases credit diversity
As for getting your actual credit report, you’ll have to read that section to find out.
If you want to read any part of this right now, there are links right above. Otherwise, the article begins right below. Hope this helps!
How to Build Your Credit Score – Canada
It’s a big day. You’re finally ready to buy yourself a place. You’ve paid off all your student loans years ago, and in order to avoid buying anything unnecessary, you only use cash and debit. Because of that, you now have enough saved up for a down payment. All that hard work has paid off.
You eagerly approach your bank to get prequalified for a mortgage. You know a few friends who are making less than you but have been able to qualify so you’re confident that it’ll be the same for you. As you wait for the mortgage specialist, you dream of your new place. The colours you’ll paint the walls. The cute Ikea furniture that will wow all your guests. You can’t contin your smile and jump right out of the seat when you hear your name called.
You follow the mortgage specialist to her office, take a seat and after you share your decoration plans, she gives you a few more suggestions and the next thing you know, you two are both laughing and envisioning the possibilities. She then realizes how off track she’s gotten and tells you that she’ll need to pull your credit score to determine if you qualify. Hah, you know that you have never fellen behind on a payment because you never had a payment to make besides your rent and phone bill. It’s going to be spotless and so you confidenatly give her the permission.
She pulls the report. Her smile suddenly disappears. She tells you that it seems like the bank won’t be able to give you a mortgage. You think she’s pulling your leg and you call her out. But her expression doesn’t change. It turned out your score was in the mid 400s.
All the colour in your face disappears. The thoughts on furniture is quickly replaced with confusion. What happened? You were so protective of your finances that you went with a debit card so that you would never overspend. And now you’re being told that you’re flagged as not being financially responsible?
You continue to ask around, and start talking to a few mortgage brokers. They typically have more access to different mortgages so maybe they can help. As you sit down with the 3rd broker, you finally get a positive answer. You can qualify for a mortgage! But the terms are way higher than the rates that your friends have gotten.
What happened? Where did you go wrong? It turns out that you never really understood the importance of building your credit score.
What is a credit score
Before we get into how to build your credit score, let’s cover what a credit score is. Your credit score is like your public financial scorecard that is used by people and companies to not only determine if you are worthy for loans and credit cards, but to determine what interest rates they will charge you for those loans and credit.
Besides your credit score being used by banks and credit card companies, your credit score can also be used by a landlord. For example, when I was renting out my house, I asked all my prospective tenants to show me their credit score. Some of them stopped replying once I did, whereas the ones who had strong credit scores did not waiver at the request. For me, a high credit score is a proxy for determining how reliable the person is when it comes to paying rent on time.
And if you’re in the financial services industry, a credit score can also be used by your employer to make sure that you are responsible with your money.
What is a good credit score
A credit score is between 300 to 900, with 650 as the “magic number”. If you’re under 650, you will find it hard to get approved, and if you do, your rates will be much higher. Above 650, and you will most likely be approved, and as your credit score goes higher, your interest rates will go lower. According to Borrowell, the average Canadian has a credit score of 749. If you’re worried about not being at 900, don’t be. The last I checked, my credit score was hovering around 800. That was enough for me to qualify for the best mortgage rates out there.
In fact, if you can do just a bit better than the average Canadian, you will most likely be getting the best terms for your loans. Here is a screenshot of how Equifax interprets their score:
Speaking of Equifax, there are two main credit unions that generate our credit scores in Canada: Equifax and TransUnion. The majority of the credit companies (think mortgages, line of credits, banks, credit card companies) in Canada will automatically report your credit related activities to these two credit unions. Once the credit unions get your information, they will update their report on you. That said, it is quite normal for your credit score to fluctuate throughout the month, and should be no cause for concern.
So now that we have a basic understanding of the purpose of our credit scores, let’s look at all the different things that can affect your score.
What Affects Your Credit Score
What exactly is used and how it gets used to determine your score is not completely transparent. However, we do know the values of the broader categories:
Payment history – 35%
“A good record of on-time payments will help boost your credit score.” – TransUnion
By far the most important thing you can do to improve your credit score is to pay your bills on time. So long as you make the minimum payment for the month, it will be reported that you have paid on time (even though you have an outstanding balance with the company). This shouldn’t be a reason to only pay the minimum as you will not be decreasing your debt (see the credit utilization section on how that can negatively affect your score) and you will still be paying a lot of interest on the outstanding balance.
So how important is it really to make your payments on time? According to the Global News article, they believe it’s about 35% of your whole score.
But that doesn’t mean that missing a payment will drop your score – it’s a little more complicated than that (for the better).
You technically become delinquent if you are one day late on paying a the minimum required for any of your loans. If you’re like me and just sometimes totally forget about making the payment until after the deadline, you’ll like this: the majority of credit card companies will not report it to the credit bureau until you miss two months in a row.
What happens after missing it two months in a row? Your score starts to drop. Dramatically. According to Investopedia, missing 3 months in a row can drop your credit score as much as 125 points and if you miss 4 months, your account may be turned over to a collection agency.
So if you are in a situation where you cannot make your payments, try to get at least your minimum payments in and reach out for support (I’m sure someone on the Facebook group can provide advice). So long as the minimum payments are made, you will not go further down the delinquency timeline.
But if do miss payment, be ready to pay the full interest on your whole balance.
Utilization Ratio (AKA Balance-to-Limit Ratio) – 30%
“Try not to run your balances up to your credit limit. Keeping your account balances below 75% of your available credit may also help your score.” – Equifax
The utilization ratio is another way of saying your credit balance to limit ratio. The idea here is that you do not want to max out your credit card if you do not need to. Because if you are constantly reaching your limit, the credit bureaus will think that you are in a financially bad situation and will drop your credit score for it.
Another thing to keep in mind: paying off your entire balance every month is not reflected in your utilization rate or, ultimately, your credit score. The balance that is used to calculate your utilization rate is based on your last statement balance. So, you could charge $900 on a credit card with a $1,000 limit and pay it off the same month, but the credit bureau will still consider a utilization rate of 90 percent.
That said, if you are a responsible person and will not spend more than you can pay in cash, I would suggest having a few of your credit card’s limits be increased. That way you will automatically have a lower credit utilization ratio.
For example, let’s say you spend $500 monthly. If your credit card has a limit of $1000, your credit utilization ratio is 50% (500 / 1000 = 50%). If however, you increase your credit card limit to $4000, your credit utilization is now 12.5% (500 / 4000 = 12.5%). In the first case, your credit score might take a hit, where as in the second scenario, your credit score will actually improve because of the low ratio.
Of course, this is assuming that you will not be tempted to spend the new amount.
Length/history of Accounts – 15%
An established credit history makes you a less risky borrower. Think twice before closing old accounts before a loan application.” – TransUnion
Don’t have any more use for that old credit card? Or are there certain bank accounts that you don’t use anymore? Closing them may make your life easier, but realize that it could affect your credit score.
Besides reporting the age of each of your accounts, credit bureaus will also report the average age of your credit. That means the more old credit cards you close, the lower your average. Similarly, the more new accounts you open, the lower your average.
Credit Karma puts it this way: Among Credit Karma members, we’ve noticed a steady rise in credit scores as the average age of open accounts gets longer.* Members with an average age of open accounts between one and two years have an average credit score of 622. Bump that age up to two to five years, and the average score rises to 638. Ages between five and eight years average 661. Finally, average ages over eight years earn a credit score of 675. The trend here is pretty clear.
Put another way, Credit Karma members with scores that top 750 have an average age of open accounts of 7.5 years. While there is no magic number or threshold here, it is fairly clear that a great credit score does usually take some time.
So if you’re not paying for the account, keep it open!
But credit history might not be the only thing that credit bureaus look at…
Changing jobs too frequently
I’m sure that we all agree that we will not be at the same company our whole life. Most of us probably won’t be at the same company for the first few years after graduation as we’re trying to find our ideal job. Society for the most part, has accepted that fact. However, credit bureaus are not the biggest fan.
The problem they see with “job hoppers” is that there isn’t as reliable a source of income as someone who stays in the same job. If they believe you do not have a reliable source of income, they will question whether you will be able to make the regular payments on the money lent to you.
That said, the longer you’re in a job, the better it will be for your credit score. Of course, I don’t suggest doing it if you have become disengaged with the role.
Recent inquiries – 10%
“Avoid applying for credit unless you have a genuine need for a new account. Too many inquiries in a short period of time can sometimes be interpreted as a sign that you are opening numerous credit accounts due to financial difficulties, or overextending yourself by taking on more debt than you can actually repay. A flurry of inquiries will prompt most lenders to ask you why.” – Equifax
There are two types of inquiries – a soft inquiry and a hard inquiry. When a soft inquiry is made, it will not show up on your file or lower your credit score.
When a company is looking to perform a non-credit related activity and are accessing your account for such things as verifying your identity, it is considered a soft inquiry. These companies are not pulling your actual credit information, but are simply trying to verify your identity and address. When you are requesting your own credit report, it is also considered a soft inquiry. Another common soft inquiry is when a you’re seeking to increase your credit limit and the company needs to go into your account.
Hard inquiries are when the company is pulling your credit report to approve you for credit. This means your credit will go down slightly for every credit card you open or loan you take out. It may not be a lot of points each time, but if you constantly do it, the credit bureau might categorize you as a “credit seeker”, making it that much harder for you to qualify for credit in the future.
Solution? Avoid making too many inquiries in one year. Also, one more thing to remember:
Avoid having too many accounts
We do not want to cross the line into having too many accounts. Having too many accounts (particularly credit cards) could get you in trouble, especially if many of them carry balances. Situations like this make credit bureaus think that you might be in financial distress, and will potentially drop your score.
Variety of credit accounts – 10%
“A healthy credit profile has a balanced mix of credit accounts and loans.” – TransUnion
There are 3 main types of credit: revolving, installment and open. Having a mix of these will show the credit bureaus that you are responsible and savvy enough to take care of your loans.
A revolving account is when you have a set amount of credit, say $1000. You will only pay for the amount you use (say $500) and as you pay it off, you get that amount back to use. The most common type of revolving credit is your credit cards.
Installment accounts on the other hand, are fixed amounts you have to pay each month. The most common example would be your student debt. Other examples are mortgages and auto loans.
Open accounts if when the balance has to paid in full every month. The most common type of open account would be your cell phone bill and utilities.
Having a mix of these 3 accounts (and diversity within each account) will help get you more points on your file than having only one type of credit, such as only credit cards.
In fact, some people have reported seeing their scores drop when they:
Have no mortgages or student loan file
A mortgage and / or a student loan is considered an installment loan – you have to make a set payment each month. Another source of installment loan is your student debt. By having some sort of installment account open, it contributes to your credit mix, which in turn increases your credit score.
However, if you pay off all your installment loans, there will be no more installment accounts which also means you do not have as diverse of a credit mix to report. The lack of credit mix will drop your score. It is also important to note that some mortgage companies do not need to report to the bureaus – mine does not. That means that you might not have your installment loan checked off by having a mortgage. The best way to find out is to get your free credit report and see if there is anything reported under the installment section.
The fact that I still have my student loan is helping me keep an installment loan open.
Errors in your Credit Report
Credit reporting is done electronically, and credit bureaus accept the information they are sent without any investigation into the accuracy of the information. So if the credit company accidentally submits the wrong information to your account, you could be losing a lot of points. Errors can be delinquent accounts reporting on your file that do not belong to you, late payments that were not late, and credit that is created from identity fraud – therefore not your credit.
There is no way to prevent the errors. The only option is to request your credit report on a regular basis to look for potential errors. The most common errors are:
- Wrong mailing addresses
- Incorrect Social Insurance Number
- Signs of identity theft
- Errors in your credit accounts
- Late payments
- Unauthorized hard inquiries
If there is an error on your file you must contact the credit bureau, then it is up to the bureau to investigate your complaint and to verify the information contained in your file by contacting the reporting creditor.
How to Improve Your Credit Score
It may have been a little depressing going through the earlier parts, but it’s not all doom and gloom! There are still many ways to increase your credit score, up to the 800s like me. So let’s get right to it.
Pay your bills on time
By far the most important thing to do. The easiest way to do this is to set up a pre authorized payment for your credit card companies so that the money is automatically taken out of your account.
If you’re currently in a financial squeeze, make sure you pay the minimum required as that will still be considered as paying on time.
Lower your utilization ratio
If you are confident that you will not spend more because of a higher credit limit, call your credit card companies and see if there is a way to increase your limit. By doing so, you should have your utilization ratio decrease.
The alternative is to pay your credit card a few times a month. That way your balance is much lower throughout the month which would mean your utilization ratio will also be lower.
Try to get a diverse set of credits
Remeber how we talked about the different types of credit accounts you should own? So even if your parents are willing to pay for your phone bill, have it under your name to win the dievrsity points. As for installment loans, I wouldn’t suggest getting one for the sake of having one as you will be paying interest on money you really don’t need, and I’m sure you can get to 750 without having to open an installment loan.
Check your score annually
The purpose of checking annually is to see if there are any mistakes in your report. If there is, notify the credit bureau to get them to look into it. Look at the Free Credit Report section to see your options.
How to Build Your Credit Score
There is no magic way of having a great credit score overnight. It takes time. It might even take years. Since time is going to go by regardless, why not build out your credit score now and have it available to you in the future as opposed to needing it in the future and not having it?
In order to build it out, I suggest taking the following steps:
1. Apply for a credit card
If you are a disciplined person, apply for a credit card. My suggestion would be MBNA or a Tangerine credit card as they give you the cash back options (see the General Tips for Cutting Everyday Expense – Credit cards section for more info). If you qualify, see if you can get the limit to be 5x more than you typically spend each month (if you spend ~$500, you want $2500). A limit that is 5x your average spending means that your utilization ratio will be around 20%.
If you cannot get a typical credit card, see if you can get a store credit card. Store cards are typically a little easier to get. Ideally, it would be a store that you go to often, but it doesn’t really matter as long as you can use it to buy from other places. Our goal here is to build your credit history and the first step is to start demonstrating that you are a responsible person that can handle credit.
2. Make purchases through the card
Now that we have a credit card, the next step is to use it so that we start building a credit history. Remember, we want to keep our total spending on the card to be less than 20% so if you’re reaching that point, paying off your credit card early would take care of that problem.
3. Pay off the card in full each month
The last step is to pay it off. The easiest way to do this is to set up an automated payment plan with the credit card company. Log in to your account and look around their site. There will be a section that will let you set up this payment plan (it is typically called a pre-authorized debit form).
4. Pay for your own phone bill
Since phone bills are considered open accounts, it will also help your diversity of credit which will, in turn, help your credit score.
Now that you have done all this, you are showing the credit bureau that you are starting to build out your credit mix, you are making your payments on time, and you are responsible with your credit (low utilization rate). Over the course of the time, this credit card will show great standing and your credit score will reflect it. Just remember to check your credit report annually to make sure everything is correct!
How to Get Your Free Credit Report
As we’ve talked about, there are two credit bureaus in Canada – Equifax and TransUnion. If you were to go to them for the reports, it would cost you $19.95 / month and $16.95 a month respectively. That’s a lot of money each month.
Luckily, both of these credit unions have partnered up with other companies to give you your credit score for free.
Borrowell is a company focused on helping people pay off their high interest credit cards by providing with loans at a lower rate. They have also partnered with Equifax to give you insight into your credit score without requiring your credit card. And yes, you can get your credit score without ever using thier services.
Signing up is super straight forward and once you do, you will see your score along with potential promotions that you might benefit from.
The nice thing about borrowell is that they will automatically update your credit score every 3 months and send you an email about it. Now you won’t ever have to remember to check it yourself.
Credit Karma offers more than your credit score. Partnering with TransUnion, Credit Karma will also give you a high level overview of your credit report. Unlike Borrowell, Credit Karma is more in the business of offering you credit cards based off your credit score. Of course, you don’t need to ever sign up for a credit card through them.
Signing up is also straight forward and requires no credit cards.
Once you’re signed up and logged in, you will see your score. As you scroll down, you will see your credit mix, credit inquiries and if you have any negative notes on your report. If you do see something that shouldn’t be there, you should talk to TransUnion to get it sorted out.
Unfortunately, unlike Borrowell, Credit Karma does not offer automated updates. However, a suggestion to keep updated is to simply sign in everytime you get your Borrowell update.
Getting your free credit report
Now that we’ve talked about the cool ways to get instant updates on your credit scores (and with Credit Karma, your report), let’s get you your free credit report.
Both Equifax and TransUnion are required to give you your credit report for free once a year.
Now that you know everything you’ll ever need to know about credit scores, here’s what I suggest you do:
- Sign up with Borrowell and Credit Karma to get your free score and report.
- Request your free credit report from Equifax and TransUnion to make sure there are no errors in your report.
- Continue to improve your credit score by following the suggestions above.
- Monitor your score online and only request your report if your score suddenly takes a nosedive as that might be a sign of some error.
What’s your credit score right now and what ways are you planning to improve it?