If you’ve ever applied for a credit product, you’ve likely received information on your credit rating, but do you really know what it means? This piece of terminology could be even more important if you’ve got bad credit and are trying to get back on your feet.
“If your credit history isn’t stellar, it can be useful in helping you move forward to understand your credit rating. Beware of any companies that promise to improve your credit rating on your behalf. That takes time and it has to come from your own efforts,” says Jeff Schwartz, executive director, Consolidated Credit Counseling Services of Canada.
Here are the types of credit ratings and what they mean.
Credit score vs. credit rating
Unlike a credit score, which is a snapshot of your financial picture at a moment in time that helps a lender decide on your credit worthiness based on a number of criteria, your credit rating is a “ranking” of your credit repayment history for a specific lender and/or credit product.
Both of these matter when applying for any credit. It depends on what method the lender is using or favours as well as the product at hand. For instance, credit scores hold more influence when it comes to qualifying for a mortgage.
What are credit ratings?
Reading your credit rating takes a little decoding. Essentially, a lender will assess your repayment history on a scale of 1-9, with 1 being the highest and 9 being bankruptcy or other failure to pay the debt in question.
They also designate letters in front of the number ranking to help the lender get a better understanding of how you’ve handled credit in the past. You’ll see letters in front of the debt rankings: “R” for revolving credit i.e. your credit cards, which is what you’ll see most often. You are responsible to pay a varying amount, depending on your balance, up until you reach your limit. “I” is for an installment loan i.e. a ‘closed’ loan, like your car loan or debt consolidation loan, where you pay a set payment every month until the balance is paid off entirely. Less commonly, you will see an “O” for open credit (where you are allowed to take out a certain amount, with the whole balance due on a specified date).
What do the ratings actually mean?
Ideally, you’d like to see an R1 or an I1 on your credit rating. This means that you’ve consistently paid your minimum payments within the 30 day required window. Basically for each 30 days beyond that that you don’t make a payment, your rating drops i.e. R2 means that you are more than 30 days behind but less than 60 days and less than two payments behind. R3 means that you are more than 60 days, but less than 90 days and not more than three payments behind, and so on.
When you get into R5 territory (when you are 120 past due on a payment) you are moving towards debt repayment through a third party, repossession and finally R9/I9, where you are essentially defaulting on the debt.
Anything beyond R5 can leave a black eye on your credit rating and will take a consistent effort over time to correct, but it can be done.
What if I have a bad credit rating?
“If you’ve got bad credit, one of the benefits of knowing your credit rating is that it helps you identify specifically where you may have struggled with credit on your history, which can help you correct your behaviour going forward. Perhaps you’ve experienced a job loss or dealt with unexpected expenses at a given moment in time. Perhaps you were living without a budget and got in over your head. This is important information in helping you get back on track,” says Schwartz.