Understanding Your Credit Score

Learn how credit scores work can help you make better financial choices.

Credit SpectrumYour credit score is one of the most important numbers when it comes to your finances. A good score helps you get the best rates and terms on loans and credit cards, while a bad score can make it difficult to achieve your financial goals. Understanding how credit scores work is essential to maintaining a healthy financial outlook.

What is a credit score?

A credit score is a three-digit number that indicates your risk as a borrower to lenders. A high score means that you have been responsible with credit in the past, making you a good candidate for new financing. A low score means that you are a high-risk borrower who may be more likely to default.

Credit scores are calculated based on the information contained in your credit report. Each consumer has two credit reports, one from each of the two main credit bureaus in Canada – Equifax and TransUnion. Thus, each consumer also has two credit scores – a TransUnion credit score and an Equifax score.

Since the information contained in the two versions of your credit report will generally be the same or similar, your scores should be as well. You will never have an excellent TransUnion score but a bad Equifax score.

Credit score ranges

Credit scores range from 300-900 in Canada. According to Equifax:

  • Credit scores from 660-724 are good
  • Scores from 725-759 are very good
  • Scores above 760 are excellent

If you have a score below 560, it’s considered poor. You may have difficulty getting approved for loans and traditional credit cards. When you do get approved, the interest rates may be much higher, making it more expensive to borrow money.

Keep in mind that different lenders often have different score requirements. A credit score of 640 may lead to a loan rejection from one lender. However, another may approve you for the same loan but charge a higher interest rate.

How are credit scores calculated?

Equifax scores

According to Equifax, there are five basic factors used to calculate a consumer credit score. Each factor has a certain “weight” as to how much it affects your score.

This factor looks at the payment history on each account, as well as how many accounts you have overall. If you’ve missed payments by more than 30 days, it will negatively affect this factor.

Accounts maintained in good standing with no missed payments will positively influence this criterion.

This measures how much of your available revolving credit limit you currently use. If you have three credit cards each with a limit of $500, then your total available credit limit is $1,500.

If you have a balance of $300 on one card, then you are using 20 percent of your total available credit. However, you are using 60 percent of the balance on that one card.

In general, you only want to use about 30 percent of your available credit, both in total and on each account.

This factor looks at how long you’ve used credit. It looks at the “age” of each account. Having old accounts that you maintain over time in good standing improves this factor.

This factor looks at the public records section of your report. If you have collection accounts, bankruptcies, foreclosures, or any other derogatory public records listed in your credit report, it will decrease your score.

The final factor looks at how many new credit applications you’ve had recently. Applying for too many credit cards and loans around the same time will hurt your score. This factor is measured by looking at the number of “hard inquiries” on your credit report, which happen anytime you authorize someone to check your credit.

In general, you should space credit applications out by at least six months to avoid damaging your credit score.

TransUnion scores

TransUnion does not expressly state weights of different factors used to calculate your score. However, they do list six factors that are typically used in scoring calculations:

  • Payment history on loans and credit cards
  • The current balance of each account
  • How long those accounts have been open
  • What types of credit you have (for example, a mortgage, credit card, and student loan)
  • Amount of credit limit currently in use
  • How often and how recently you’ve applied for new credit

Maintaining a good score

While credit scoring models may differ, these actions will always have a positive effect on your score.

Pay your bills on time

Be diligent about making your payments on time. Keep in mind that a payment missed by one day won’t be reported to the bureaus. Payments missed by more than 30 days will be. So, you can make the occasional mistake and your credit will not suffer. But falling behind on your bills will decrease your score.

Don’t max out your credit cards

Keeping your balances low is also great for your score while running up balances to their limits will hurt you. Ideally, paying off credit card charges in full every month is the best thing you can do for your score.

Keep accounts open and in good standing

You want to show creditors that you can maintain your accounts properly over time. So, if you have an old credit card, use it periodically to keep the account open. Be aware that unused accounts may eventually be closed by the credit card company.

Plan carefully for credit applications

If you know you want to buy a car next month, don’t apply for a credit card this month. Get your car loan first then wait a few months to apply for the credit card. This will ensure you get the best possible interest rate and terms on the loan. Then you can get the card later.

It’s important to note that if you apply for a mortgage or car loan and want to shop around for the best rate, the credit bureaus will group the inquiries and treat it as one inquiry. However, this does not apply to personal loans or credit cards.

Diversify your credit over time

As you get comfortable using credit, you should gradually take on different types of accounts. A mortgage is good debt and keeping it in good standing looks good on your credit. Having a few credit cards isn’t bad but having a mix of credit and loans is better.

How does debt affect your credit score?

Having excessive credit card debt and other revolving debt is bad for your credit score. If you start to carry balances on multiple cards and those balances exceed 30 percent of the available limit on each account, your score will start to gradually decrease. The higher the balances go, the lower your score will drop.

Things get worse if you start to fall behind on your payments, and worse still if those accounts go into collections. It can be a slippery slope as you fall into financial hardship.

The good news is that you can turn things around. What’s more, nothing in credit lasts forever. Negative information only stays on your credit report for so long. Once the information expires, those penalties that are hurting your score disappear, too.

How getting out of debt may affect your score

It’s important to recognize that some debt solutions may negatively impact your credit score, particularly those that create public records. If you file for bankruptcy or a consumer proposal, it will be listed in the public records section of your credit report. This will hurt your score.

For this reason, you want to be proactive if you see that you’re facing challenges with debt. While bankruptcy can give you a fresh start, the damage it can cause to your credit may hold you back for some time.

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