One way to determine your financial creditworthiness is to know your credit score and how it is calculated.
You can get free credit reports from Canadian credit reporting agencies such as Equifax and TransUnion once a year, but they do not include a credit score.
Until recently, you either had to pay for this information (Equifax charges $23.95) or sign-up for a paid service such as TransUnion’s subscription-based credit monitoring service ($16.95 per month). Now, online lending companies such as Borrowell and Mogo offer free credit scores when you sign up for an account.
What is a credit score?
A credit score is a three-digit number from 300 to 900 which is calculated using your credit history from your credit report. Your score will change over time as your credit report is updated.
Your credit score is used to predict your future risk of default and can affect the rate of interest you will pay. Users can quickly come to a decision.
The higher your score, the better – but just up to a point. Over 70% of Canadians have a credit score over 725 (very good to excellent). Less than 13% have scores over 850.
A very good rating (and up) would be considered a very low risk. You may qualify for a variety of loan and credit offers at the lowest rates available (saving you thousands of dollars), higher limits on credit cards, and special incentives and rewards.
But not only lenders are checking. Landlords will determine if they will rent to you, utility companies see whether you should pay a security deposit, car insurance providers consider it when setting your insurance rate, and cell phone companies check before offering a new contract. Even some employers are checking your score.
It is important to know your credit score well in advance of shopping for a mortgage or loan so you can take steps to increase your score if necessary.
Are you hurting your credit score?
Even if you make your loan payments on time and pay off your credit cards in full each month, you may be unknowingly hurting your credit score.
- Not checking your statement. An outstanding balance of even less than $5 that you don’t notice – and don’t pay.
- Closing old credit cards, especially those without a balance.
- Signing up for multiple retail and department store credit cards to receive their discounts.
- Some credit card issuers do a “hard” enquiry when you request a credit limit increase.
- Multiple enquiries by landlords and utility companies.
Knowing how the score is determined can help you increase it
The specific algorithm used to calculate your credit score is proprietary information. Each credit bureau and lender uses their own specific data and each score can be different. Generally, this is how various factors are weighted.
Payment history – 35%
Do you pay your bills on time? More recent delinquencies hurt your credit score more than those in the past.
Debt level – 30%
The amount of debt you have in comparison to your credit limits is known as credit utilization. Keep your credit card balances below 70% of your credit limit, even if you pay in full each month.
Length of credit history – 15%
Many of us switch credit cards to take advantage of more favourable terms and rewards. If you do this leave at least one long-term account open. Having a longer credit history is favourable because it gives more information about your payment habits.
Enquiries – 10%
Too many enquiries will reduce your score temporarily. Check interest rates online rather than going from lender to lender to apply for your mortgage or loan. Each one will do a credit enquiry, lowering your score each time.
Mix of credit – 10%
Having different kinds of accounts shows that you have experience managing a mix of credit types.
However, only open new accounts as you need them, not simply to have what seems like a better mix.
Lenders and other third parties will consider many factors in addition to your credit score when evaluating your creditworthiness and coming to a decision. Lenders use the 5 C’s of credit (Capacity, Capital, Collateral, Conditions, and Character).
Your credit score isn’t the only factor, but it is hugely important. Make sure yours is very good or excellent.