Your credit score is an important part of your financial profile. Understanding how credit scores work, why they’re important, and what you can do to improve yours is essential to your overall financial well-being.
A credit score is a number ranging from 300 to 900 that represents how likely you are to pay your bills on time, also known as your credit risk. This score is used by lenders to evaluate your request for credit (like when you want to buy a car or take out a mortgage) and determines if you qualify for a loan and at what interest rate.
How Credit Scores Work
In Canada, credit scores are officially calculated by two major credit bureaus: Equifax and TransUnion. Some factors used to calculate this score include your payment history, the amount of credit you’re using, and the length of your credit history.
The higher the number, the better your credit score which means you have demonstrated responsible credit behavior in the past and thus you are more likely to be approved by lenders. Here is a general breakdown of credit score ranges:
- Poor credit: 300-579
- Fair: 580-669
- Good: 670-739
- Very good: 740-799
- Excellent: 800-850
It is important to keep in mind there are many different scoring models and some take into account your income as well. But according to Equifax, here is a detailed breakdown of the main factors that are considered to calculate your score:
- 35% Payment history (do you make your payments on time?)
- 30% Used credit vs. available credit (how much of the total available credit is being used on your credit cards?)
- 15% Credit history (how long have your credit accounts have been in existence?)
- 10% Public Records (any prior history of bankruptcy or collection issues?)
- 10% Inquiries (are there any signs of financial distress that appear on your credit file?)
Why Are Credit Scores Important?
As we’ve discussed briefly so far, credit scores can have a huge impact on many big decisions in your life, like renting your apartment or deciding whether to change an interest rate or credit limit on your credit card.
In a nutshell, people with higher credit scores generally receive better credit terms, which means lower payments and less paid in interest over the duration of the account. In addition to having a better chance of being approved, a good credit score will also get you a better interest rate. The lower your interest rate = the less money you have to pay to interest.
Even if you have a great income, pay all your bills on time, have no debt BUT you’ve never had any credit history, you won’t have a credit score. And this means you won’t be able to take out a house loan.
How to Improve Your Credit Score
Your credit score is extremely important and so you should do everything you can to improve it. Luckily there are many techniques at your disposal:
- Always pay your bills on time. If you miss payments or are late on bills, your credit score will go down.
- Don’t take out a lot of lines of credit within a short period of time.
- If you don’t have any credit, get some now. The easiest way to do this is by opening up a credit card. The longer your credit history, the higher your credit score.
- Avoid high credit card balances and high balances on loans.
- Make sure your credit reports are accurate.
Also remember that your payment history doesn’t just include your credit card bill, it also includes things like your cellphone bill. So make sure to be on top of all your payments!
The bottom line, consistency is key. Heather Battison, vice president of TransUnion Canada explains that “the most important factor for building and maintaining your scores is to pay your bills on time and in full each month. This activity demonstrates your ability to responsibly manage credit and can positively impact your credit scores.”
Hopefully, this article answered most of your questions regarding the importance of your credit score and gave you some practical tips on how to improve it. Your credit score is ultimately one number that can both cost and saves you a lot of money, so be sure to review your credit report regularly and keep it healthy!
When was the last time you checked your credit score? You can check your credit scores directly from TransUnion and Equifax!