Credit
7 mins
Everything You Need to Know About Credit Scores
Author
Danny Randell
Published
Jan 24, 2024
Credit scores are an important part of daily life and can affect your ability to qualify for a loan or even secure a job. However, there’s a lot of mystery surrounding credit scores and how they work. We pulled together all you need to know about them to help you demystify this complex financial rating system.
What is a Credit Score?
A credit score is a three digit number that can range anywhere from 300-850 which offers lenders a rating of an individual’s creditworthiness.
To explain further, if a bank were to give you a loan, your credit rating should give the bank an indication of how likely you are to pay them back. (And specifically, pay them back on time.)
Depending on what number you’ve been assigned by a credit bureau, a lender will decide on whether or not they are comfortable with you borrowing their money. The higher your score is, the lower their risk is in loaning to you, thus, the more likely you are to be approved.
How are Credit Scores Calculated?
Calculation is where credit scores can get a little complex, and may be the reason why according to the Bank of Montreal, 31% of Canadians don’t know what goes into a “good” credit rating. (Don’t worry, you’re about to find out!)
So what exactly do credit bureaus look at to come up with your three-digit score? A bunch of things. Including how well you’ve paid back debt in the past, how much debt you use, how long you’ve had access to credit, public records (e.g. if you’ve previously declared bankruptcy), and the number of credit inquiries associated with you.
Now Equifax only weights credit inquiries as making up 10% of your total calculation, but credit inquiries are probably the most misunderstood aspect of credit scores. There’s a misconception that the more times you personally check your credit score, you are actually damaging your score. This is false. An inquiry only refers to when you are actively seeking credit (e.g. applying for a credit card). You can check your credit score anytime without negatively impacting it.
How to Tell if You Have a Good Credit Score
According to Equifax, a major credit reporting agency, there are five main categories when it comes to credit rating: poor, fair, good, very good, and excellent. Equifax associates the following scores with each category:
Poor - 300-579
Fair - 580-669
Good - 680-739
Very Good - 740-799
Excellent - 800-850
Transunion — the other major credit reporting company in Canada — goes by slightly different numbers for each of these categories, but the general range remains the same. Ultimately, there isn’t a ton of difference between the “good” and “excellent" categories. Once you have a good credit score, you are likely going to qualify for most of the loans you apply for.
It’s important to remember that credit scores aren’t static, so it’s worth checking in on your rating every once in a while (especially if you’re trying to build your score).
How Does Credit History Affect My Credit Score?
Contrary to popular belief, the most important aspect of your credit score is actually not your credit history, but your payment history. Credit history (often confused with payment history) refers to how long you have held your credit accounts, while payment history refers to your repayment record.
According to Equifax, your credit history makes up just 10% of your credit score total, while your payment history makes up for 35% of the calculation. While it goes without saying that the most important thing to do in order to have a good credit score is to pay back any money you borrow to your lender, it doesn’t hurt to have a longer credit history either. A longer credit history accompanied by a strong repayment record demonstrates to lenders that you can be counted on to pay back the funds that you’ve borrowed.
Can I Improve my Credit Score?
Everyone can improve their credit score simply by making the right decisions. If you don’t have a credit score at all and would like to start building your credit, an easy way to do this is to set up a pre-authorized debit, meaning you are allowing a company to automatically charge you for a service you regularly pay for. For example, you can apply for a credit card and set up a bill to be paid with the card each month (e.g. your Netflix subscription, cell phone bill, or utilities bill). Just don’t forget to pay off your new credit card at the end of the month!
If you already have credit (e.g. a personal line of credit, car loan, or credit card), simply make your payments on time to your lender to improve your credit score. Remember that the primary way to increase your credit score is to pay off any debts you incur. For example, if you get a five year car loan and pay your vehicle off in five years or less, that’s going to positively impact your score.
Essentially, lenders are looking to loan money to individuals who are classified as low risk and who are highly likely to repay a loan. Any activity you can do to increase your creditworthiness will decrease your risk level and inversely, increase your credit score.
Credit Tip
When it comes to credit cards, you must make your minimum payment to keep your credit score intact, but if you want to improve your credit, we recommend making more than the minimum payment and in fact, totally clearing your credit card balance if possible. Paying off your credit card —in full— at the end of every month, will improve your credit score.
For more advice on how to deal with outstanding debt, check out this blog post.
What Things Can Hurt a Credit Score?
Things that can negatively impact your credit score might include taking out multiple loans, not paying your bills on time, not paying your bills at all, or failing to pay off your credit card balance. According to Equifax, previous declarations of bankruptcy can also affect your credit score.
Why is a Credit Score Important?
Your credit score is important because it can affect your ability to qualify for a credit card, a mortgage, and sometimes even getting a job. Credit scores are often included in comprehensive background checks, so if an organization you’re working for requires a background check, be advised that they will likely also pull your credit.
If you’ve never had credit, there are still some loans which you are likely to qualify for; for example, a student loan or a cell phone contract where the phone is advanced to you up front. However, you may find it difficult to obtain a car loan or small business loan.
A good credit score will help you qualify for all kinds of loans that can help you find housing (i.e. mortgage), build a business (i.e. small business loan), or deal with everyday expenses and collect rewards (i.e. credit card).
Conclusion: Checking Your Credit Score
Checking your credit score is a very easy process and completely free! Simply follow these steps outlined on the Government of Canada’s website to verify your score with either of the major credit bureaus in Canada, Equifax or Transunion. These companies are verified and recommended by the federal government and you should not rely on any other agencies to accurately report your credit score.
Knowing your credit score and how it can affect your day-to-day life is empowering and will help you make beneficial financial decisions. Feel free to bookmark this article so you can quickly refer back to how credit scores work and recall our tips on how to keep your score “in the green”!
