Credit scores. You’ve heard that term and you know that ideally, like with most things you’re scored on, that you should have a good one but what is it? Why do you need a good one? How do you get one? And when do you start?
Let’s dive on in!
Back to Basics: Credit + Debt
Debt is money that you owe to somebody.
Credit is money you can borrow.
Let’s try it IRL: Imagine borrowing a friend's jacket, as a pal you have social “credit” with them so they let you use the jacket, expecting you to return it. Once you have the jacket, that is a debt you must pay back.
If you return the jacket to them they will be more likely to lend it to you in the future because you have paid back your debt in the past. Credit is similar, by building your credit score, lenders will see you are more likely to pay them back so they feel it is less risky to lend you money.
So what’s a credit score?
A “credit score” is a three digit number between 300-900 that is a historical record of your ability to pay back someone you have borrowed from.
You are in control of your own credit from the moment your first bill is due. Once you start paying for things (like phone bills, rent, credit card statements, and student loan payments) you need to be ready and able to pay for them when the bill comes.
(like a bank) will look at your credit score to determine if they want to lend to you and then figure out the “credit terms” that will be associated with the lending.
Say, what? Credit terms?
“Credit terms” could be anything from the interest rate you can get on a mortgage or if your landlord requires additional months rent as a down payment before they will rent to you. In our previous IRL example, a credit term could be your friend requiring you to buy them a new jacket if you ruin or lose theirs.
Okay, let’s get down to the numbers.
If you have a lower credit score, let’s say between 300-600, it can make it challenging to get loans, properties, or other credit services. Still, it’s never too late to start building it!
740-799: Very good
The better your credit score (or as a lender will see - your ability to pay back the money you owe them!) the more likely you will get better credit terms.
But if you have a lower credit score, let’s say between 300-600, it can make it challenging to get loans, properties, or other credit services more difficult. But it’s never too late to start building it!
Want to check your own credit score? Canada has several free websites to use like Credit Karma and Borrowell (these websites use a soft credit check so it will not impact your score, more on that later)!
So how do I actually build my credit score?
There’s not a straightforward response, so let's focus on the five most important things to do to build/maintain your credit, outlined by the Government of Canada.
1. Make your payments
This is the most important step to building your credit. A late payment will remain on your credit score for seven years and is one of the most common causes of low credit scores. The most common example of a payment affecting your credit is paying your credit card balance each month before the statement deadline. It is critical that you at least make the minimum payment on your credit card so that the do not see a missed payment. If you can, try to pay off the entire balance to avoid the expensive interest that is associated with most credit cards. Other types of payments, like loan payments and rent (if your landlord reports payments to a credit bureau) also need to be paid on time! This is THE single biggest way to impact your credit score. Never missing a payment is the best way to build your credit over time: set reminders in your calendar for when payments are due, get your phone to notify you through online banking when statements are ready, or set up auto payments for a portion of your debt that you can afford each month so you are reducing how much you owe as fast as possible.
2. Know your limit and stay within it (or well under it)
Lenders of credit typically don't like you to use all of the credit you’ve got available. Ideally, they are most pleased with people that use 35% or less of their total available credit. For example, Faizan has a credit card with a of $1,000. The credit bureaus will increase Faizan's credit score the most, if he uses less than 35% of his credit limit on a regular basis (aka $350 of his credit card limit each month). Now Faizan does have a $1,000 credit limit, and it will not hurt his credit score if he uses up to his credit limit, but it will slow down his credit score improvements. BUT Faizan should never use more than his total available credit limit, if he borrows more than his agreed limit his credit score can decrease.
So in summary: less than 100% of your limit is good, less than 35% of your limit is GREAT!
3. The longer record, the better
The longer you have a credit account open and in good standing, the better your score. Keep at least one older credit account open even if it is not your primary credit card because this increases the historical record of your credit. Just make sure you won't be paying any fees if you don’t use the account. Contact the credit provider to see if you are paying fees when deciding if you should keep an account open or not.
4. Credit checks, soft vs. hard
When you apply for a credit product, let's say a car loan, the seller of the car will want to know that three digit number - your credit score. The car salesman will have to do what is called a “hard credit check” where they ask a credit bureau for your credit score. A hard credit check will lower your credit score for 12 months, however after two years will be removed from your credit report entirely. The reason a hard check lowers your score is because lenders don’t want people applying for more credit products than they can afford, so they lower the score to prevent this. For example: If you apply for five or six credit cards at the same time, the credit bureaus will see this and could lower your score.
Soft credit checks on the other hand have no impact on credit score (this is what Credit Karma and Borrowell do). A soft credit check is when you want to check your own credit score, or if you have an existing credit account (eg. credit card, mortgage) with a business and they want to check your score to update your account.
5. Diversify your credit products
One way to build your score is to have multiple types of credit products. Credit products include:
A line of credit
When you have these different products, credit bureaus are able to see that you can keep track of multiple types of debt, and that different groups are willing to lend to you, and it builds your credit history. BUT, and this is a big BUT, do not take on debts that you can't pay back just because you want different credit products to build your credit score.