Now, more than ever, Canadians could use some debt management advice. The average Canadian now owes $1.71 for every dollar of disposable income, and the problem is only getting worse.
Well, there are several benefits when it comes to debt management, and one of the most important is your credit rating. So, why is your credit score so important, and what can you do to improve it? Glad you asked.
Let’s talk about credit score, what factors go into it, and how to boost your own!
Why Credit Score Is So Important
Your credit score is the best way creditors have of judging your creditworthiness, and it’s how they make decisions about who they lend to. When taking out a larger loan like a mortgage or car loan, a difference in your score could be the difference of hundreds or thousands of dollars. Also, it could be the difference between getting a loan or not!
If you have a decent credit score and you want to take out a mortgage of $300,000 for a new house, think about how important your interest rate is. The small difference between 2% and 3% is $3,000. 3% and 7% have a difference of $12,000.
You wouldn’t spend an extra $12,000 on a car or tuition if you didn’t need to, so why would you spend it on a house? That’s $1,000 a month for an entire year that could be saved by simply improving your credit score.
Not only is there a financial incentive, but having a good credit score will also open doors for your life decisions. With a bad score, you may not be able to own a car or a home, go back to college, and you may find yourself trapped in high-interest debt.
Well, understanding your credit score and following the best practices will prevent that! Unfortunately, only 33% of Canadians view their scores as important!
Factors in Credit Score
Before we explain the factors, let’s quickly run over how your credit is scored. The score runs between 300 and 850, with the highest being the best. A “good” credit score is anything above 680 to 700, depending on who you ask.
A poor credit score is below 540, a fair or decent score is between 540 and 680, and an excellent credit score is anything above 750 or 770. Now, let’s talk about the factors that determine these scores.
For this, we will go in order from least important to most important. Now, there are minor and major adjustments that could affect your credit score, including major lifestyle changes, declaring bankruptcy, and others. However, these are the primary factors.
The way your score measures your new credit lines is primarily by looking at your hard inquiries, accounting for 10% of your score.
For certain types of credit applications, your lender may have to place a hard inquiry on your credit report for a more detailed history. If you apply for a large auto loan, student loan, or mortgage, the lender will almost certainly inquire on your credit report.
However, this isn’t a major issue for your credit score. Hard inquiries only last on your report for a maximum of two years, and they are often gone within just a few short months.
Also, the damage they cause is minuscule. After one or two hard inquiries, you may see a temporary dip of between 2 and 10 points, but this will change soon if all else goes well. Although, you may want to prevent too many hard inquiries from taking place within the same time frame, if possible.
Also accounting for 10% of your score is credit mix. How many lines of credit do you have? Well, the more, the merrier!
That’s right, having multiple lines of credit in good standing improves your score and tells potential lenders that you know how to manage debt properly. Although this doesn’t have a massive impact, opening an extra account could work in your favor!
However, it’s important to note that more revolving credit lines (like credit cards) can actually harm your score. New installment loans (personal, auto) will help improve it. Creditors want to see that you can handle a healthy mix of debt at one time.
Length of Credit History
Okay, we’re now entering “medium impact” territory, so beware! This accounts for 15% of your score!
In all seriousness, creditors want to see that you’re able to keep your lines of credit open and in good standing for long periods. However, it does this by measuring the average.
Unfortunately, paying off your auto loan a year early may not give you the credit boost you were hoping it would. Although, you can make up for this with your credit cards.
If you have a couple of credit cards, leave them open for as long as possible to help drive up your average. For this particular factor, there is no quick fix. Patience is a virtue!
Credit Card Utilization
Next, we’re getting into serious territory. Credit card utilization accounts for 30% of your score, so pay attention!
Let’s say your credit limit is $10,000 on your credit card. You charge $3,000 on your credit card in one month and you make a payment of $1,500. Your credit card utilization at the time of your statement will be 15%.
Now, you’ve kept it under 20%, which is great. However, you want to aim for under 10%. Keeping your utilization below 1% is fantastic, but it will help to go above that occasionally and pay it off later on.
You want to use your credit cards. You don’t want to keep them inactive. If you’re worried about overspending, lock them away and leave some subscriptions (Netflix, YouTube Premium, etc.) on them for recurring payments and pay them off at the end of the month.
Also, if your credit card utilization is over 20% and you have a high-interest rate, you may want to consider a personal loan. Not only will it help lower your interest, but it will add an additional line of credit to your report!
Finally, we’re at the most important one on the list, accounting for 35% of your score. You have to make consistent payments every month.
If you’re worried about forgetting, make automatic payments of at least the minimum just in case. Otherwise, set reminders on your phone, ensure you’re receiving the creditor’s emails and notices, and do what you need to do to avoid missing a payment.
Delinquent payments leave scars for up to 7 years on your credit report. If you’re a day late, your creditor will likely charge you a fee, but it won’t necessarily hurt your score.
However, if you are 30 days late, they will almost certainly report it to the major credit bureaus, which will damage your score. If you pass the 60-day or 90-day marks, the damage will be even worse.
Even one missed payment on a perfect record could drop your score by as much as 100 points, especially if your credit is relatively new. Your payment history alone could be the difference between a 2.5% interest rate on your mortgage and a 6% interest rate. Unfortunately, as many as 1 in 5 Canadians missed a debt payment during the pandemic.
How to Increase Credit Score
To achieve a higher credit score, you must first understand the factors mentioned above and where you fall behind. Unless your credit score is a perfect 850, there is always room for improvement.
Overall, the best way to boost your credit score is to just keep making consistent payments, don’t overuse your credit cards and don’t take on any debt that you can’t manage. No matter where you fall behind, that will offer the best long-term strategy.
However, sometimes we find ourselves needing a “quick fix” for our credit scores. Well, if your credit score is below 680, then there are some things you can do to start repairing it.
First, you should take out loans to pay off your high-interest debt. This will establish a new line of credit and save you some extra money.
Next, if you’ve had to declare bankruptcy, or if your score is very low, then it’s time to start rebuilding your credit.
Lastly, if it’s your first time building credit, then you need to open a line. Apply for a credit card or a personal loan and make consistent payments every month! Building credit takes time and consistency, but the sooner you do it, the better.
Start Rebuilding Today!
Now that you know the important factors of a credit score and how you can start building credit, this knowledge won’t help you unless you put it to use! Stay up to date with our latest personal finance news, and feel free to contact us with any questions!