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Enriched Academy Staff
If you are looking for ways to better your financial situation, one of the first tasks you should be focusing on is how to build your credit score. Your credit score is a measure of your demonstrated ability to meet your loan commitments and other bills in a timely manner. It is one of the key metrics to measure your financial progress. The higher your score, the more likely a lender is to loan you money and the lower the interest rate you will receive.
What is a good credit score?
In Canada, your credit score is derived from a credit report issued by either TransUnion or Equifax and the credit score range is between 300 and 900. The Canadian average is around 650. Good credit scores over 750 offer a higher chance of loan approval, greater borrowing limits, and lower interest rates and insurance premiums. If you want to get the lowest advertised mortgage rates you are going to need a top-notch credit score. At the other end of the scale, a low credit score of under 600 may make it very difficult to get a mortgage from a Canadian bank.
Potential interest savings from an excellent credit score are huge on big-ticket items. Qualifying for a preferential rate on your mortgage could easily save you tens of thousands of dollars. For example, an excellent credit score could qualify you for a $500,000, 5-year fixed mortgage at 4.5%, while a low credit rating could see you paying near 6%. You would save $20K+ during that 5-year period! Vehicle loans offer even greater variation depending on your credit rating and are another area where a bad credit score will take a lot more money out of your pocket every month.
Understanding how to boost your credit score and building the highest score possible will open doors to many opportunities and save you money. If you are looking for a quick hit to improve your financial literacy around credit scores, take 3 minutes of your time and watch, “How Does Your Credit Score Work” on the Enriched Academy YouTube channel.
How to check your credit score?
The first thing to note is that a credit report and a credit score are not the same. Your credit report is available free online from either credit bureau in Canada (TransUnion or Equifax) and contains a summary of your credit history. Your credit report does not contain your credit score. The credit bureau determines your score using a formula based on a number of credit factors, but they don’t share that formula. Although we can guesstimate, It is impossible to know exactly how much your credit score will change based on the actions you take.
You can check and monitor your actual credit score from a number of different sources — banks, finance companies, credit unions and specialty “credit score providers” can all provide your score. They often include it free if you are an existing customer or if you are willing to register and provide an email address.
Who looks at your credit score?
Credit scores are used for a lot more these days than just whether you qualify for a loan. Insurance companies, potential employers, and landlords are just a few of the people that will often check your credit score and use it for decision making.
Employers may request a background check and a credit check before they will formally offer employment. It is legal in Canada to make this request and it is often a requirement for jobs in government, finance, and many other industries.
Landlords will often ask for a credit check before offering you a lease; even utility providers may review your credit history to decide whether or not you need to pay a security deposit to connect to their services.
If you have your eye on the perks that go with obtaining one of those premium credit cards or are looking to increase the limit on your credit card, obtain a business loan, or secure a personal line of credit, your credit score is going to be a big factor in whether or not you are successful.
What affects your credit score?
There are 5 credit score factors:
1. Payment history (35%)
This is the largest determinant of your score and the most critical factor to manage. You need to always make the minimum payments and avoid anything ever getting to the “collections” stage – this includes parking tickets, mobile phone or other utility bills, student loans, and credit cards.
2. Credit utilization (30%)
If all your credit cards are maxed out, your credit utilization rate is 100% and it indicates to potential creditors that you are overextended. Carrying some credit card debt won’t lower your score (as long as you make the payments each month) but try to keep your balance under 30% of your credit limit at all times.
3. Length of credit history (15%)
It takes time to build your credit score, so get a credit card when you turn 18, use it, and pay it off in full each month. A car loan or student loan will also help greatly with your credit history check — but only if you stay current with the payments!
4. Credit mix (10%)
Using a mix of different types of credit will increase your score. When you are young the only credit available may be a credit card, but as you grow older adding a car loan, student loan, or line of credit to the mix will help improve your score.
5. Credit application frequency (10%)
Applying for a lot of new credit in a short timeframe will negatively affect your score. Potential lenders do what is called a “hard pull” on your credit history when you apply. You want to avoid having a number of hard credit pulls in succession as it may look like you are desperately seeking more credit.
How do I fix my credit score?
Credit scores are continuously evaluated and adjusted. If you have "errored" in the past, rest assured that the damage is not permanent! There are ways to improve your credit score over time if you use credit responsibly, but it is much easier to avoid mistakes that lower your score in the first place.
The time required for your credit “indiscretions” to disappear varies. Unpaid debts may not be legally collectible after a couple of years (depends on the province) but can stay on your credit report for five or more years. If you have filed for bankruptcy, that will stay on your credit report for seven years.
If you have mended your financial ways and have reached out to your creditors and are now paying your bills on time/making the minimum payments, perhaps using a secured (pre-paid) credit card — how long does it take to improve a credit score? The answer varies widely from case to case, but you should see your credit score start to rise between four and eight months down the road — don’t expect to boost your credit score fast!
Check your credit score regularly!
If you are looking for some simple financial advice that pays huge dividends — check your credit score on a regular basis! It will allow you to track fluctuations and overall improvement, detect errors, and prevent identity fraud. Checking your own score does not form part of your credit application history and does not affect your credit score!
Errors and omissions are not uncommon in credit reports, and it is a good idea to confirm the details of your report. Both TransUnion and Equifax have a process to report mistakes and get them corrected. It can take up to six months to resolve disputes with a credit bureau as there may be some time-consuming back and forth with you, the creditor, and the bureau.
Helping you increase your credit score often falls outside the scope of services for financial advisors, even though it is one of the most critical aspects of building wealth. Although it is something you are going to have to manage yourself (or tackle it together with your financial coach), the reality is that it isn’t all that difficult.
There is a lot of confusion and plenty of urban myths when it comes to credit scores, so make sure to do your research and more importantly, pay attention to your credit score. If you see it has gone up or down significantly, you may be able to pinpoint a cause or specific action that caused the change. The worst mistake you can make is to ignore your credit score. Sooner or later you are going to need it and the better it is, the more favourable the outcome is going to be.