What Exactly Is Credit?
A credit score is essentially a number that represents your financial responsibility for potential lenders.
For borrowers, it is an indicator of their ability to get better borrowing options and interest rates in the financial lending market. For lenders, it indicates the level of risk and responsibility associated with a borrower, and helps them determine whether or not they are worth lending to.
Credit scores range from 300 to 900, with the average Canadian credit score hovering in the range of 650.
Your credit report is made and held by two credit bureaus in Canada:
These bureaus are responsible for protecting your information and only giving it to lenders whom you have given consent to access it. Every time to apply for credit, you are giving a lender access to your credit report through one of these bureaus.
How Is Credit Determined?
Your credit score made up of a series of factors:
Payment History (35%)
How often you borrow and how often you repay your debts makes up the largest proportion of what determines your credit score. Lenders want to know how well you can repay your debts should they choose to lend to you. Your payment history is made up of payments such as your student loan, car loan, phone contract, credit card, and anything else you have a line of credit on. The better you are at making payments on time while limiting late payments, the better your payment history looks for lenders.
Amounts Outstanding (30%)
When you apply for credit, lenders will look at your debts currently outstanding. They want to know what your current financial obligations are, and it helps them determine if you are going to be able to make payments on time, given your current obligations. Generally if someone owes a lot of money, they will be less likely to keep up with more payments. This is a critical piece of information that lenders want to know, which makes it the second most important factor in determining your creditworthiness.
Length of Credit History (15%)
Lenders want to know how long you have been a borrower because it determines how responsible you are with long-term liabilities. The longer and more actively you’ve been using your credit, the better it looks on your credit report. Lenders ultimately want to deal with people who are more experienced with debts, as it decreases the risk they need to assume to deal with them.
Applications Outstanding (10%)
This is in your credit report because it shows how many different lines of credit you are using at a given time. Even if you manage your debts well, having many lines of credit on your report shows lenders that you are reliant on loans to live within your means.
Credit Type (10%)
Your credit reports what kinds of credit you’re using because it helps lenders understand where you have your debts allocated, and how you handle your money. Examples of credit types include car loans, student loans, mortgages, phone contracts, and other debt liabilities. However revolving credit (debt that is quickly acquired and paid off like a credit card) makes a bigger impact on your credit score than a long-term loan that is paid in periods towards a principal amount (like a mortgage or car loan).
How Do I Improve My Credit?
One of the best ways to improve bad credit is to use the credit you already have wisely. That means not going over your credit limit, and not borrowing more than what you are authorized for. A good rule of thumb is to use less than 35% of the credit you currently have access to.
Increasing the length of your credit history is another great way of giving your credit report a better look for lenders. Transferring old credit to a new account is considered a new credit transfer on a credit report thus increases the amount of credit Applications Outstanding you have, as mentioned earlier. If you have an older line of credit that you may not need, it’s better to keep it because it looks better on your credit history. It shows you have had credit for a longer period of time, so make sure you use it once in a while to keep it active.
Limiting the number of credit checks or applications is another way of allowing your bad credit to recover. There are two types of “hits” that impact your credit report.
A Hard Credit “Hit” is an inquiry that shows up on your credit report, and these are inquiries often made by lenders in order to determine your eligibility for credit.
Hard Credit “Hits”
- Applying for a line of credit
- Lease or rental applications
- Some employment applications
A Soft Credit “Hit” is an inquiry that appears in your credit report but no one but you can see them. Therefore, they essentially do not affect your credit.
Soft Credit “Hits”
- Requesting your own credit report
- Businesses asking you to update your credit account information with them
Mixing up the types of credit you use is also important for rebuilding your credit because it diversifies the type of debt you are using. This will not only decrease your own personal financial risk, but also the risk of lenders as well.