Despite the aversion to the debt being generally hard-wired into our heads, a strong credit record can do wonders for a person throughout their adult and professional life. A credit score is like a report card for one’s financial history, it determines the size, type, and cost of any loans they might need at any point in the future. The most common types of credit a person comes across in life are a credit card and a mortgage, both of which are crucial in life, and having a great score can save you tons of money compared to someone who didn’t prepare for it or neglected it. A great credit score can also serve you very well should you ever choose to start a business as it can help you borrow the amount of capital the business requires and help you get it at a cheap rate.
Today we will look at the basics of a credit score and the steps/habits you should take as a borrower to ensure that you maintain a high score. As mentioned above, a credit score is a track record of your financial dealings. Your credit score is collated across multiple data points from different financial institutions such as banks, insurers, etc., and is published by companies such as Equifax and TransUnion. Both these credit score companies have different methodologies by which your score is computed. While the methodologies largely involve the same inputs, the differences come from the weighting of the methodology. Before we lay down some guidance about improving your credit score, we will break down its functioning. You can check with your bank or any financial institution you will be dealing with about their choice of credit score providers.
A credit score is expressed as a number, usually ranging from 300 to 900, with higher scores representing a stronger borrower and vice-versa. Most good-quality borrowers would be around the 750 level. The more crucial inputs that go into a credit score include credit payment history, credit limit history, the credit history (history of borrowings), types of credit used, and credit inquiries.
Ways Your Credit Score is Impacted
We will now look at the specifics of these inputs and how you should manage them to maximize your score –
Credit Payment History
Your credit payment history is your track record of clearing your debts when the tenure of your credit expires. Having a track record of repaying loans on time or before time has a positive impact on your credit score and gives lenders confidence in lending to you. You ideally aim to repay any dues before time consistently to signal that you are a safe borrower. Your payment history has a 35% weightage on your credit score.
Credit Limit History
Your credit limit history is a track record of how much credit you use in comparison to your sanctioned amount. The lower you borrow compared to your credit limit, you stronger your credit score will be as it gives lenders confidence in your financial health. Ideally, you should aim to stay within 70%-80% of your available credit limit to signify that your finances are well managed. Your credit utilization holds a 30% weight in your credit score calculation.
Every time you try to borrow, the lender will check your credit score before extending you a loan or credit. Frequent checks on your credit score are a bad sign and each subsequent check lowers your score as it signifies that you are actively looking for credit but not availing/getting it for some reason. Inquiries hold about 10% weight in your credit score. Apart from situations where you are looking for credit or financing a purchase, credit scores might be inquired for various purposes such as renting a property, etc. Your credit score might also be checked for the new BNPL products, where the interest is generally borne by the seller to increase sales and you are only on the hook for the capital. There are two kinds of inquiries that can impact your credit score. The first kind is a hard inquiry, which is made by a financial institution/lender/banker or any party that needs to check your credit standing. Hard inquiries reduce your credit score while soft inquiries, ones made by yourself to check your credit score, don’t impact your credit score.
Credit History and Types
There are various types of credit available to people, the most of which are credit cards, lines of credit, or mortgages. Lines of Credit are amounts sanctioned by the bank against which you can draw a loan, if and when required. Proper usage of multiple lines of credit signifies that you are responsible for your finances and increases your credit score. Credit History is simply a track of all the loans or credit you have taken over your track record. This includes any loans you might have taken as a student, or loans for specifics such as auto loans, etc. Proper servicing and repayment over your entire credit history improve your credit score. Your credit track record may also include any public record checks such as a check for any past financial disputes or bankruptcies. Your credit history, types, and public record checks make up 25% of your score.
How To Improve Your Credit Score
Some simple ways to build a strong credit history apart from the ways listed above are drawing a small credit line against your bank balance and repaying it on time or using your credit for small regular purchases such as fuel, groceries, and small miscellaneous expenses.
You must also check your credit score once in a while to ensure that it doesn’t have any factual inaccuracies. It must be noted that while you can recover from a low credit score, you can only do so to an extent and any black marks on your credit history are permanent.
Since 2008, the credit markets all over the world have been flowing with cheap money as interest rates hovered at sub 1% levels to spur economic activity. The results of these actions were sustained consumption activity and a housing boom, which is one of the biggest credit markets in the world. However, this party is about to come to an end as the latest round of quantitative easing resulted in an inflation disaster that nobody expected to this degree.
As a result, we are about to enter a credit era that we haven’t seen for the better part of two decades, and if you are young, probably never have seen it. To tame inflation and asset bubbles such as those in real estate (especially in Canada), central bankers are hiking rates at an unprecedented rate. The objective of these hikes is to slow down the pace of economic activity to tame inflation. As a consequence of these rate hikes, the cost of borrowing will ramp up for borrowers at a substantial rate and for a sustained period. Therefore, having a great credit score is more important than ever.
Ways to Build Your Credit in Canada
Keep your old credit card open, use it for occasional small purchases, and set it to automatically pay for any of your recurring expenses on your streaming service account. Many big banks offer New Immigrant credit cards and low credit lines as part of their original banking package, such as the welcome to Canada package by the Royal Bank of Canada and the Scotia Start Right program. New arrivals to Canada who do not qualify for an eligible personal RBC credit card are subject to the bank’s usual eligibility and lending criteria, including Canada’s credit history. So getting a new credit card to build your credit might be a good idea.
Canadian lenders offer secured cards that help build up your payment history, significantly influencing your credit rating. Use a secure card to make purchases and create your payment history, and you will see your credit rating improve over time. Also, unwinding a credit history and substantial credit score can help a large deposit be made when you manage a credit card, mobile phone or car loan.
The advantage of using a secured card is that your repayment habits are reported to the credit bureaus, enabling you to create the necessary credit history. Paying your credit card bills on time and paying them on time will help you build a strong credit history and avoid high-interest charges. If you keep a credit card account open you used in recent years, build up your credit history, as your total available credit plays a role in credit utilization, showing lenders your ability to repay your debt without missing deadlines.
Read our article about the top-rated credit cards in Canada to choose the best one for you.
Carrying a balance and making your payments on time will help more your credit history than paying out in full each month, but we would never recommend having a credit card with you to increase your score. Regular use of your credit card and monthly repayments will help improve your credit rating, but not necessarily the quickest. If you pay your credit cards in full within the first three to six months after receiving them, your points will not be as high as if you pay your bills every few years.
It takes time to achieve an excellent credit rating in Canada, and it can take between three and six months to build up enough credit to accomplish a credit rating at the base level. On average, a bad credit score can turn into a good one if it takes six years to pay bills on time. If you open a credit card account or any loan, you do not have a credit score.
One of the easiest ways to get good credit in the US is to open a credit or account such as a credit card or credit line and pay them from time to time. If, however, you need to open an account for yourself or a credit card, your credit rating will start to have a positive or negative impact. In addition, if you come from a country that does not use credit reference agencies, your established history will not transfer to the Canadian system, and you will have to start from scratch.
Your payment history and debt level play a significant role, as do the question of how long you have your credit accounts, the mix of loans you hold and how many new accounts you have. Closing credit accounts can also affect your credit rating, affecting your funds’ average age, which is an essential part of your financial history. Every financial decision you make can affect your creditworthiness, from your ability to get a job or credit to credit cards, basic utilities, renting an apartment, or leasing a car.
Financial programs can help build your credit history by allowing you to create and pay to a secured account reported to Canada’s credit reporting agencies and added to your credit report. Credit card companies are not the only ones documenting your billing and usage history, as the three credit bureaus reporting on your credit score are Experian (r), TransUnion (r) and Equifax (r). In addition, consistent on-time payments on federal student loans can improve your creditworthiness, which is vital for future borrowings and credit card applications. Check out the best personal loans for a low credit score in Canada.
On the other hand, TransUnion considers the different types of loans you use and looks for a good mix of revolving credit accounts such as credit cards and credit lines and installment loans such as student loans and mortgages. Consider these accounts in the 10% of your score that should be considered when applying for new loans. A better option is to keep a credit card account open that you have used in recent years and use it if your lender has not closed it for lack of use.