Having a solid credit history and a good credit score can really pay off, giving you access to lower interest rates and other financial perks. But what exactly is a credit score, and how can you improve it if yours isn’t where you want it to be?
A credit score is a three-digit number that lenders use to evaluate how trustworthy you are with credit. In Canada, these scores range from 300 to 900 points, with higher scores indicating lower risk to lenders. There are various types of credit scores, such as Beacon and FICO, produced by lenders and credit reporting agencies. While the exact formula used to calculate these scores is a well-kept secret, the Financial Consumer Agency of Canada (FCAC) highlights some key factors: your payment history, the percentage of your available credit that you’re using, the length of your credit history, the types of credit you’ve used, and how many times your credit report has been checked.
Unfortunately, many Canadians don’t fully understand credit scores and may inadvertently damage their rating. “On a daily basis, we talk to people trying to raise their credit score who, in fact, end up lowering it,” says Sheldon Wolf, president of Canada Credit Fix, a credit repair agency.
If you’re working on improving your credit score, here are some key tips to keep in mind:
- Boosting Your Credit Utilization Ratio Helps More Than Full Repayment Your credit utilization ratio measures how much of your available credit you’re using. This is the second most important factor in your credit score after your payment history. To improve this ratio, you can either increase your credit limits (which isn’t always possible or advisable) or reduce your credit usage. Maxing out your credit card is particularly harmful, even if you pay it off every month. Wolf explains that depending on when your balance is reported to the credit bureau, your score could be negatively impacted for up to 90 days. A balance exceeding 70% of your limit can cause your score to drop significantly, so the FCAC recommends keeping your debt below 35% of your available credit.
- Mortgage or Rent Payments Don’t Improve Your Score Mortgage debts are typically not reported to credit bureaus, even though a good score is necessary to secure favorable mortgage rates. Similarly, rent payments don’t contribute to your credit score, despite landlords often requesting credit reports to assess the risk of renting to you. Eric Putnam, Managing Director of Debt Coach Canada, explains that rent is considered a prepaid expense, not credit, which is why it doesn’t impact your credit score.
- Canceling Old Credit Cards Can Lower Your Score After paying off high-interest credit cards, some consumers think that closing these accounts will improve their credit rating. However, this can actually hurt your score because the length of time you’ve successfully held credit accounts is crucial. Closing your oldest accounts can shorten your credit history, negatively impacting your score. The consolidation loan you used to pay off your cards may also count as new credit with a high balance-to-loan ratio, which could further lower your score.
- Credit Scores Can Vary Across Agencies It’s important to know that your credit score can differ depending on the credit reporting agency. Wolf notes that Equifax’s score may not match TransUnion’s score for the same person. Additionally, the score you receive when you purchase your credit report might differ from the score a lender sees because they might request a different type of credit score tailored to specific risks, such as for a mortgage.
- Small Unpaid Balances Can Hurt Your Score Even tiny unpaid balances can have a significant impact on your credit score. Ellen Roseman, a consumer advocate, shared a story about a reader whose credit score dropped drastically due to an unpaid store card balance of just three pennies. This small oversight led to much higher mortgage rates from secondary lenders and disqualified the person from getting a line of credit. This example shows the importance of regularly checking your credit report for errors, even minor ones.
- Wealthy People Aren’t Exempt From Monitoring Their Credit Wealthy individuals are often prime targets for identity theft and credit fraud, making it essential for them to keep a close eye on their credit scores. Wolf emphasizes that no one is immune to errors on their credit report. He shared a case where a client’s credit limit was drastically reduced by American Express due to a wrongful collection on his credit report, which wasn’t his debt.
- You Don’t Need a Perfect Score While a perfect credit score of 900 is nearly impossible to achieve, the good news is that you don’t need a perfect score to get the best borrowing rates. According to David Trahair, a chartered accountant and author of Crushing Debt, a credit score of 811 will qualify you for the same favorable rates as a score of 900. However, it’s still worth striving for a high score because the savings can be substantial. Trahair notes that consumers in the top credit score category (811 to 900) can save $47,500 on a $100,000 loan over 10 years compared to those in the lowest tier (180 and below).
In summary, understanding and managing your credit score is crucial for financial health. By being aware of how your credit score is calculated and taking steps to improve it, you can open doors to better financial opportunities and save money in the long run.
