Explaining the Credit Score

Having a good credit score is a way to ensure that you experience less financial barriers in life.  A low rating, on the other hand, can force you to work through some unfortunate obstacles. Every adult will need to have their credit score checked at some point or another by lenders, banks, or even potential employers. At first glance, it can seem like an arbitrary number, but there is a lot of calculation that goes into those three digits.

The Basics

Whether you applying for a loan or a rental, it’s likely you’ve needed to pull your credit score. This score will determine what type of loan you are eligible for and the rates that will go along with it. Scores range from 300 to 900. The goal is to be as near to 900 as possible. Anything below 500 generally requires professional credit improvement help. The average credit score in Canada is between 600-650. That being said, when it comes to your ranking, strive to be better than average. Scores 700 and above will typically have little to no trouble getting approved for new credit. In addition, the higher your score, the lower the interest rate on your potential loan.

The Breakdown

These scores are not arbitrary numbers—they are determined by a common formula that involves five different factors:

  • History of Payments (35%) – This portion reflects if payments were made on time and in full.

  • Debt/ Utilization (30%) – This next factor looks at your debt to available credit ratio. For example, Person A has a credit card with a limit of $1000. They have an outstanding balance of $700. Person B has a credit card with a limit of $5000. They have an outstanding balance of $3000. Person A will score less in this area because they owe 70% of their limit while Person B only owes 60% of their limit. So remember, it’s not the amount of money you owe, but the ratio to your limit. Experts suggest keeping your balance below 35% of your available credit.

  • Credit Length (15%) – The longer a credit account has been open, the better for your credit score. Try to cancel newer credit cards and keep older ones open.

  • New Inquiries (10%) – Each time your score is pulled, your rating will go down. This is so that lenders can see if you are applying for a lot of new credit all at once. Luckily, this is only a small portion of your score and the effects don’t last long.

  • Diversity (10%) – Having credit cards and different types of loans shows your potential lender that you are responsible enough to handle several different credit accounts.

Buffer Your Score

By knowing exactly what factors affect your credit score, you can successfully implement strategies to improve it. Comb through the list above and identify which elements might be holding your ranking down. Loans Canada gives some great tips on how to increase your credit score over time. In addition, remember that mistakes do happen and errors can occur in your credit file. Lenders will not take the time to investigate your file further, so correcting those errors is entirely up to you. Order your credit file at least once a year to ensure that everything on it is accurate and up-to-date.

Credit scores are a great way for lenders, insurers, landlords, employers, and utility companies to evaluate your credit behaviour and assess your creditworthiness. Knowing exactly what they are looking for is a great way to improve your score and effectively access the products and services they offer. If you need to build up your credit, but don’t know where to start, contact the experts at Source Mortgage today!

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