What determines your credit score?

Part 1

Maintaining a good credit score is a very important aspect of our financial health. Your credit score is something that could have a very large impact on your life, as many people and institutions use it to decide if they would like to do any business with you. It comes into effect when you apply for any kind of loan, such as a mortgage or car loan, but it can also be important when you apply to a landlord to rent a home! Let’s look at some credit score basics today, and learn how it comes about.

Credit scores are determined by companies called “credit bureaus”, of which there are 2 in Canada: Equifax and Transunion. The credit bureaus collect information on your finances, in order to put together a credit report. From the credit report, they are able to determine your credit score. In ascending order of importance, here is the information credit bureaus use to determine your credit score. 

1. New credit applications

Every time you apply for new credit, such as a credit card, your score may drop by a few points. These are called hard credit checks. On the other hand, there are soft credit checks which do not affect your credit score.
Tip: Make sure you know which check will be done when applying for credit, and don’t apply too many times in a short period.

2. Types of credit

The more types of credit you have, the better. Someone with credit cards, loans, mortgages, and utilities in their report are in a better position than someone who simply has a credit card. Having a mix of credit types shows bureaus that you are able to manage all of them.
Tip: Have a couple of credit cards, a phone or internet bill, and a personal line of credit under your name, in addition to a mortgage if you happen to have one.

3. Length of credit history

The longer your credit history, the more willing institutions will be to lend to you because they see you as trustworthy. A 19 year old who just got a credit card a month ago won’t be in the same position as a 40 year old with 20 years of credit history.
Tip: Don’t cancel your old credit cards even if you aren’t really using them. Keep them open to show that you have a long and reliable credit history.

4. Credit usage rate

Credit bureaus want to see that you’re not using up all of your credit all the time. If you have $50,000 worth of credit but you’re constantly using more than $40,000 of it, this is seen as a poor habit. Keep your credit usage rate to the 30% level.
Tip: Whenever you receive a call saying you are preapproved for a credit card limit increase, take it. Your usage percentage will go down, and it won’t even cost you a hard hit!

5. Timely payments

This is the granddaddy of them all. Making your payments on time is the most important factor. No matter what type of credit you have, it’s paramount that you always pay on time.
Tip: To help you pay your bill on time, you should set up automatic bill payments through your bank so even if you forget, your payments will be paid regardless.

Now we know what is on your credit report, and how your credit score is determined. The natural next question is, how does a good credit score affect you? Keep an eye out for our next education article on credit to find out just how important a good credit score can be!