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What Are Credit Scores and Why Are They So Important?

In Canada, your credit score ranges from 300 to 900, 900 being a perfect score. If you have a score between 780 and 900, that’s excellent. If your score is between 700 and 780, that’s considered a strong score and you shouldn’t have too much trouble getting approved at a great rate. When you start hitting 625 and below, your score is getting low and you’ll start finding it more and more difficult to qualify for a loan.


What does a low credit score mean?

A low credit score doesn’t mean you’ll never be able to borrow. Some places might still lend you money, although at a higher interest rate. This is one of the ways you’ll find your credit score really matters: the better your score, the less you pay on interest.


Your credit score is calculated using five factors:

  1. Payment history (35%)

  2. Debt utilization ratio (30%)

  3. Credit history (15%)

  4. Credit application frequency (10%) 

  5. Credit diversity (10%)

Most of the information is automatically removed after 6-7 years (although not purged).

1. What’s your payment history?

This is obviously the most important factor affecting your credit score. Prospective creditors want to know that you are going to pay them back. Your payment history covers all of your consumer debt: credit cards, lines of credit, student loans, car loans, cell phone payments on contract, etc.


CREDITORS WANT TO KNOW

  • Do you pay your bills on time?

  • How frequently do you miss a payment?

  • How many times have you missed a payment?

  • How old are your missed payments?

2. How much do you currently owe?

When creditors look at how much you owe, they’re trying to determine whether or not you are able to take on more debt. Besides looking at the amount of debt that you currently have, lenders will look at what’s called debt utilization ratio: that’s the amount of credit you’re using compared to the amount that’s available to you.


For example, if you have a credit card limit of $5,000 and you’re constantly hovering at $3,600, then you’re using 75% of your available credit on an ongoing basis. To a creditor, that indicates that you’re struggling to pay off your existing debt.

Creditors will also look at how much outstanding debt you have compared to how much was available to you.


CREDITORS 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. How long is your credit history?

Creditors want to see a long established history of managing credit. There’s nothing more frightening to them than somebody walking out of the woods with a clean slate. A good credit history is built over time and that’s something you can’t lifehack.


CREDITORS WANT TO KNOW

  • How long has it been since you first obtained credit?

  • How long have you had each account for?

  • Are you actively using credit now?

4. How frequently are you applying for new sources of credit?

Frequently applying for credit is a flag for creditors. If you frequently sign up for new credit cards, loans or other forms of credit, lenders may conclude that you're not able to manage your money.


CREDITORS WANT TO KNOW

  • How many times did you request a hard 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 was your most recent inquiry?

5. What kind of credit have you used?

The kinds of credit you use can say a lot about how you handle your finances. There are two kinds of credit: revolving credit and installment credit.

Installment credit comes in the form of a loan that you pay back regularly (once a month, bi-weekly, whatever it may be). The amount of the loan is set when you are approved and the sum that you borrow doesn’t change.

Revolving credit on the other hand is not a predetermined amount. You will have a credit limit that sets how much you can borrow up to, but you can pay it off and spend it again indefinitely.


CREDITORS 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 do you check your credit score in Canada?

Nearly half of Canadians (47%) don’t know where to check their credit scores.

In Canada, your credit score is calculated by two different credit bureaus: Equifax and TransUnion. You can request a free copy of your credit report by mail at any time though your credit score is not included on the reports.

Both of these bureaus can provide you with your credit score for a fee, and also offer credit monitoring services. For more information visit TransUnion or Equifax.


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