Demystifying Your Credit Score

Nearly 24 million Canadians have a credit file. Credit is a part of modern life, and so too is the credit score, even though most people only have a vague idea of what it is.

If you thought you could just ignore your credit score, think again – your score can determine everything from how much interest you pay on a loan, to whether you qualify for a mortgage, credit card or even an apartment rental.

Here’s a quick credit score primer so that you’ll be a well-informed borrower in the future.

The Report

It all starts with your credit report, which contains detailed entries on every loan and credit facility extended to you in the last six years. You can get your credit report at either of the two credit bureaus in Canada, TransUnion and Equifax.

You’ll probably be surprised by the amount of information in the report. It will outline your payment history, how much debt you have outstanding, and what your credit limit is on each account. You’ll also see a list of parties who have accessed your report in the last several years.

A Secret Formula

Your credit score is basically a numerical expression of your report, calculated by using a proprietary formula developed by the credit bureaus. Scores range from 300 to 900, and the higher the number, the better.

While the threshold for what constitutes a ‘good’ number is not exact, scores above 700 are generally considered to indicate strong credit worthiness. Borrowers with a 700+ score will usually be approved for most loans and should receive credit at highly favourable interest rates. At the same time, those with a score under 650 will probably have trouble getting new credit. And below 500? Forget about it.

The Factors at Play

The precise formula used to calculate your credit score is a closely guarded secret, but what is well known are the three factors that most contribute to the number. Once you know these factors, you can figure out how to boost your score.

Here they are:

• (1) Your credit history. Have you paid back your debts consistently and on time for a sustained period? Prompt and consistent payments lead to higher scores.
• (2) The inquiry activity on your credit report. Frequent inquiries into your credit report will damage your score. It seems a bit counterintuitive, but credit bureaus view frequent inquiries into your file as a sign that you could be on shaky financial footing.
• (3) Your proportion of outstanding debt to total credit. The higher your credit balances are relative to your total credit, the more it will hurt your score. Credit experts suggest keeping balances in each credit account below 50 percent of the total credit limit. In a way, this factor makes a lot of sense: the more maxed out a borrower is on their existing credit, the less likely they will be to pay back additional debts they take on. One way to help your score is to spread your debts among several lenders rather than maxing out a single account.

The Other Consideration: Errors

Industry observers say up to 25 percent of all credit files have material errors. Many of these mistakes can damage a consumer’s credit score.

It’s important to review your report every few years. If you find an error, contact the credit agency as soon as possible. Equifax and TransUnion both have dispute forms that you can fill out and submit free of charge. You should also remember to include any supporting documentation, along with a brief explanation of your case. The agency then takes the next step of contacting the party whose entry you are contesting.

If the party refuses to change their entry, you can add an addendum in your credit report telling, in essence, your side of the story. You can also take the additional step of contacting the consumer advocacy authority in whatever province you live in. Of course, in 2013, taking to social media might also be effective. The party in question may give you a fairer hearing if you contact them on their facebook page or twitter account.

Wrap-Up

Credit scores can help you or hurt you, depending on the number. That’s why it’s a good idea to consciously engage in practices that will raise your score, and to take a look at your credit report every couple of years, especially if you’re planning to apply for a large loan or a mortgage.

Credit scores, it turns out, don’t have to be mysterious – you just have to know how they work as you go about managing your finances.