How Your Credit Score Affects You
Your credit score is critical to your financial health, as it rates your creditworthiness. Essentially, your
credit
score determines how much money you can borrow, what interest rate and how much in fees you'll have to pay. Your
credit score is based on your credit report, which includes information about your credit history - your payment
history, how much debt you owe, how long you've had credit, the types of credit you have, and how often you
apply
for credit.
In Canada and the US, most lenders use the FICO credit score system, which ranges from 300 to 900. The higher
your
credit score, the more likely you will be approved for a mortgage and the better the terms you'll receive.
For example, if you have a credit score of 750 or higher, you can get a mortgage with a low interest rate and a
small
down payment. A lower interest rate means lower monthly payments, which can save you thousands of dollars over
the
life of your mortgage.
On the other hand, if your credit score is below 600, you may have difficulty getting approved for a mortgage and
may
be required to make a larger down payment or pay a higher interest rate. A higher interest rate means higher
monthly
payments, which can make it harder to afford your mortgage payment and other expenses.
Significant Factors Impacting Your Credit Score
Here are the most important factors affecting your credit score:
Defaulting on a loan has the most severe negative impact on your credit score. It means you
have failed to repay the
loan as agreed, and it can stay on your credit report for up to seven years. A default can
significantly reduce your
credit score and make it challenging to get approved for credit in the future.
Payment history is the most significant factor determining your credit score. Late and
missed payments significantly
reduce your credit score. The longer you delay your payments, the more it negatively affects
your score. Even one late
payment can have a considerable impact on your credit score.
Credit utilization is the ratio of outstanding credit card balances to credit limits. A high
credit utilization ratio
indicates that you are using a significant amount of your available credit, which may
suggest that you are overextended
and need help to make payments. Keeping your credit utilization ratio below 30% is ideal for
maintaining a good credit
score.
When you apply for credit, the lender performs a hard inquiry on your credit report. Too
many hard inquiries in a short
period can lower your credit score as it suggests you are actively seeking credit and may be
at a higher risk of
defaulting on your payments.
Closing credit accounts also negatively impacts your credit score, especially if you have a
long credit history.
Creditors prefer to see that you have a lengthy credit history and can manage multiple
credit accounts effectively.
Closing an account will reduce the average age of your credit accounts, which can harm your
credit score.
Maintaining a Healthy Credit Score
Here are some tips to keep your credit score healthy:
- Pay your bills on time every month
- Keep your credit card balances below 30% of your credit limit.
- Don't apply for too much credit. Only apply for credit when you need it.
- Apply for credit products with lower interest rates you will likely be approved for (e.g. personal loans)
- Check your credit report regularly. Errors on your credit report can hurt your score, so you must check your
report
regularly and dispute any errors you find.
- Build a long credit history. The longer you've had credit, the better it looks to lenders. If you're new to
credit,
consider getting a secured credit card. With a secured card, you'll need to make a deposit upfront, which is
collateral
for your credit limit. Making regular payments on a secured card can help build your credit history and
improve your
score.
Building Up Your Credit Score
Improving your credit score takes time and effort, but because it results in getting the best terms on your
mortgage,
it is worth it. Here's how you can improve your credit score:
The first step to rebuilding your credit score is to get a copy of your credit report. You
can request a free copy of
your credit report from Equifax or TransUnion in Canada. Review your credit report carefully
to identify any errors or
inaccuracies that may negatively impact your score. If you find any errors, dispute them
with the credit bureau.
While having debt - if you are paying it off on time - helps you build your credit score,
the amount of debt you have
limits the amount you can borrow. If you have high credit card balances or other debts, work
on paying them down as
quickly as possible. If you're using a significant amount of your available credit, this may
suggest that you are
overextended and may struggle to make payments. The less debt you have, the better your
credit utilization ratio will
be, which can help improve your credit score.
Start paying your bills on time with no exceptions. Make this the #1 priority each month.
Creating a monthly budget
helps you take care of your financial health. You can use a budgeting app or a Google or
Excel sheet to plan your
expenses.
If you are struggling to rebuild your credit score, consider seeking professional help from
a credit counselor or
financial advisor. They can help you develop a plan to improve your credit score, manage
your debts, and create a
budget.
