Your credit score is a number that lenders look at to assess your credit worthiness when you apply for a loan or mortgage. It tells the lender how risky it will be for them to lend money to you. A credit score can range from a low of 300 to a perfect score of 900. The average credit score in Canada is around 700 but for most a credit score above 680 will mean you will qualify for a mortgage or loan with a good rate. If you want to qualify for an insured mortgage you need a minimum credit score of 600+.
Your credit score is important in determining:
- Whether you qualify for a loan.
- The interest you will pay on your loan.
But what factors affect your credit score? How do Equifax and Trans Union calculate your score? Knowing the answers to these questions is critical to understanding what you can do to improve or repair your credit and lower your interest costs.
Your credit score is calculated based on 5 key categories. These categories are weighted for the entire population as shown in the chart below but each person’s calculation is unique. For the general population payment history has a relative importance of about 35% however if you have not had a long history of using credit your payment history may be weighted more heavily. It is important to know exactly what goes into your credit score so that you can make improvements where possible to improve your own credit rating.
Paying your bills on time is critical to maintaining a good credit score. Your payment history includes whether or not you have any reported instances of late payments, write-offs, liens for unpaid debts, and if you have had debts placed in collection. Even your phone bill payment record (eg Rogers or Bell) is now included in your Equifax credit report. If you have filed bankruptcy, made a proposal to your creditors or used a debt management plan to repay your debts this is where it will be reported. Any of these items remain on your credit report for a specified period of time.
The second largest factor usually affecting your credit score is the amount of debts you owe. Credit rating agencies also look at the types of debt you carry including credit cards, mortgage loans, car loans, lines of credit and other bank loans. Having debts does not mean you are a high risk debtor. In fact, having some debt is generally seen as a good thing. Your credit score takes into account:
- your available credit (how much you were approved for) by type of loan.
- your balance outstanding (which may be based on your last bill, even if you have paid it off in full).
- your credit utilization rate. Having a low balance owing relative to your maximum credit available is much better than being maxed out on all of your credit cards. You do not however have to carry a balance on your credit card. Other credit like telephone bills, utility bills etc will also be looked at by your lender as positive use of credit if these are paid off regularly.
- your percentage of accounts with balances. Having a balance outstanding on a large number of accounts (ie having several credit cards with even small balances) can be an indication that you are a high risk lender.
- how much you owe today compared to the original loan amount. Showing that you can pay down an installment loan (like a car loan or student loan) is a sign of responsible credit use.
In addition to your balances and payment history, credit scoring agencies also look at how long you have used credit. However, even if you have only been using credit for a short period you can still have a good credit score if you show positive results for all other factors.
Type of Credit Used
Your score will also be impacted by the types of credit you use. Payday loans may report payments to your credit report however these types of loans are looked upon less favourably than mortgages or car loans for example. Having said that, secured credit cards can help an insolvent debtor improve their overall score after a bankruptcy or other debt relief alternative if they are able to show a period of making reliable payments.
Your score does not drop just because you apply for new credit, nor does it drop because you request a copy of your credit report. Be careful however when applying for new credit. Repeated applications for new loans that are turned down can have a negative effect on your credit score. New credit can also help you overcome past poor payment history (including bankruptcy, a consumer proposal or a debt management plan) allowing you to re-establish your credit by making payments on time on these new loans.