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Your Credit and You: The Basics

credit score CanadaCredit cards, mortgages, auto loans and leases all revolve around 3 numbers, your credit score. Credit scores have become an obsession for Canadians. With over $1 trillion of debt, Canadian consumers have good reason to pay attention to the three digits that in large part determine their ability to access credit, and the price they’ll pay for it.

 

What Is A Credit Score? How Does It Affect Me?

A credit score is simply a measure lenders use to determine the likelihood that you will default on a loan payment, typically defined as being 90-120 days past due. Lenders will use your credit score, provided by a risk models like FICO‘s Beacon Score or the VantageScore, in addition to their own criteria to help them determine whether to approve you for credit, what interest to charge you for that credit and at what terms.

How Is A Credit Score Calculated?

A credit score is determined by the credit files that reside with the two Canadian credit bureaus, Equifax and/or TransUnion. Your credit file contains the information about your credit related activity that your lenders report to the bureaus, such as which credit products you have, your credit line size, balances owed, credit inquiries, and timing of your payments.

A credit score is derived by a mathematical interpretation of the activity on your credit files. The higher the number, the better your credit score, ranging from 300-900. Lenders will then use the credit score and combine it with other data points collected from your application such as income, employment status, and  home ownership, to determine your credit worthiness.

Fico Beacon Credit Score

 

What Factors Influence Your Score The Most?

There are many factors that impact your credit score, each with varying degrees of importance. Below is a breakdown of the factors and their relative influence for VantageScore. The three most important factors are paying on time (payment history), the amount of debt you have relative to your credit lines (utilization), and how many different debt products you have and the maturity of those accounts (depth of credit).

Improve Your CreditAs you can see from this chart, the most important factor to having a good credit score is paying on time. That does not mean you have to pay your credit card in full every month. It just means you have to pay the minimum on time.

The second most important factor is utilization. Utilization is the measurement of your total debt to your overall credit lines. A good rule of thumb is to make sure your credit card balances do not exceed 30% of your credit card’s line.

How Many Points Can Your Credit Score Increase Or Decrease From Doing XYZ?

1. Missed payments: If you’re 30 days late on your credit card, your score can drop between 60-90 points. If you’re 60 days late, your score drops by 70-105 points. You don’t have to pay off your entire balance, just pay the minimum required by your credit card company.

2. Using all available credit on one credit card can lower your credit score by 55-110 points. If you have to keep a balance on your credit cards, spread the total credit card balance across multiple credit cards, rather than maxing out a single credit card. Multiple smaller balances will have less of an impact than a single high balance, although it will still have an impact.

3. Closing an old credit card account can reduce your credit score by 10-30 points. When you close a credit card account, you also lose the value of that card’s credit limit in the credit score calculation, which will likely cause your balance to limit ratio to go up. This can trigger an additional decrease in your credit score. However, if that doesn’t apply to you, i.e. you don’t keep a balance, it will only minimally impact your score, and it will be reversed in a matter of months. Moreover, you won’t lose the value of the maturity of the card on your credit file, as both Equifax and TransUnion currently keep a record of your accounts on your file for 10 years, after closure.

4. Making an inquiry will drop your score between 10-20 points. If a lender runs a credit check on you and obtains your credit score to determine your credit risk, an inquiry is report to the credit bureaus. If your behavior is otherwise solid, your credit score will rebound in a few months.

5. Opening a new credit card will decrease your credit score by up to 5 points. But again, this will be temporary and, assuming otherwise could behavior will correct itself in a few months.

6. Accounts getting older by one year will increase your score by 1-3 points.

7. Reducing your credit card utilization to 30% of limit will increase your score by 20-50 points. The easiest way to quickly improve your score is to reduce your credit card balances substantially and to maintain good behavior for 2 months.

What Are The Rules of Thumb For a Good Credit Score?

1. Don’t be late. Your first missed payment will hurt you the most, but additional missed payments will continue to lower your score.

2. If you have to miss a payment, better to do it on your credit card than either your mortgage or your auto loan.

3. Apply for credit when you need it. If you’re approved, the impact from making an inquiry will quickly disappear and your score will recover after a few good payments.

4. If you do shop for credit, do so in a short period of time. Most credit score models take rate shopping into consideration and provide a window of say 14 days. As a result, if you shop from multiple lenders within the window, it will be considered as a single inquiry.

5. If you have to keep a balance on your credit cards, spread the balance out over multiple cards, will have less of an impact on your score than a single high balance exceeding 30% utilization on one credit card.

6. Stay under 30% credit utilization on any given credit card. You can do this decreasing your balance or increasing your credit line.

7. Instead of closing unused, older credit card accounts keeping them can help improve your score by several points each year, just make sure there’s no annual fee or inactivity fee charged by the issuer.

We would also suggest you practice these practical pieces of advice. Keep reserve lines of credit available to give yourself flexibility for unexpected expenses. Get those reserves lines of credit when you don’t need them (not when you’ve lost your job), and keep them handy. Budget effectively in the first place to avoid inability to pay. Perhaps the most effective piece of advice  is to set-up automatic payments from your checking account to your credit card account, so you’ll never be late.

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