Understanding credit scores and reports
If you’re considering buying a home or have started looking into financing, you’ve likely come across the term “credit score”. That’s because your credit score has a big impact on your ability to borrow money and how much it costs to do so. By understanding credit scores and knowing how to read your credit report, you can plan ahead, make confident decisions and may even benefit from more favourable credit terms.
What are credit scores?
A credit score is a three-digit number assigned to you, which is made up of points, ranging from 300 to 900. It is used by lenders to gauge how well you manage your money and therefore how risky it may be for them to lend to you.
Your credit score changes over time depending on a number of factors, which are used to “score” your ability to manage credit. If you are using your credit responsibly, you will get more points or a higher credit score. However, if you are having trouble managing your credit, by not paying balances on time, for example, then you will lose points and will have a lower score.
Credit scores are significant in various aspects of life, including for getting favourable rates on loans or mortgages, renting apartments and even job applications. That’s why it’s important to stay on top of your credit score and know how to improve it, especially if you intend to borrow money for a big purchase, like a home.
How do credit scores work?
Your credit report is a summary of your credit history. As soon as you apply for or open a line of credit, such as a credit card or a loan, a credit report will be created to track and score how you use and manage your credit.
Lenders, such as banks, will send information about your accounts to the credit bureaus, which then use that data to generate your personal credit report.
The two major credit reporting bureaus in Canada are Equifax and TransUnion. These are private companies that gather and store your credit history based on your Canadian finances. Note, if you come from another country, you may find some financial institutions that are willing to recognize your credit history from another country, but you will have to check with them directly.
Lenders will use your credit score to determine the terms and interest rates of your loans, such as mortgages, auto loans and credit cards. The higher your score, the more trustworthy you are deemed to be in the eyes of the lender and therefore the more likely you are to be approved for a loan and receive a more favourable rate. If your score is poor, then you may not be approved at all or will have to pay a higher rate of interest on your borrowings.
How do I get a credit report?
Before you can start working on your credit score or setting your financial goals, you should have a clear understanding of where you stand, now. You can request a free copy of your credit report from Equifax or TransUnion online, by phone, by mail or in person. You will need to provide proof of your identity and/or address depending on how you make your request. You may also have to give your Social Insurance Number.
If you use online banking, you can usually access your credit score, along with other useful tools and information about your credit usage, when you sign in. RBC has a step-by-step guide on where to view your credit score in online banking, so you know what to expect.
Note that checking your credit score has no impact on your score. You can and should check your score as frequently as you need to in order to stay on top of your finances.
Once you have your report, be sure to review it and make sure everything is accurate. If you do find any discrepancies or errors, then it’s important to report it to the lender, as well as the credit bureau, as quickly as possible. Not only could an error hurt your credit score—it can also be a sign of fraud or someone trying to steal your identity.
What does a credit report look like?
The Government of Canada website has a clear breakdown of what you can expect to see on your credit report. Along with personal information, such as your name, address and social insurance number, you will also find detailed information about your financial history, including when you opened an account, a list of any lines of credit you’ve had or have and any missed payments. You can also access sample credit reports from Equifax and TransUnion.
What is a good credit score?
A credit score is a number from 300 to 900. The higher your number, the better your score. According to TransUnion, the average credit score in Canada is 650, which would be generally considered a “good” score. However, with a score above 700 you are more likely to get approved for a loan and receive lower rates on your borrowings. And a score above 750 would often be considered “excellent” and may afford you even better rates.
A score below 600 is considered “poor” by most lenders, which can make it much more difficult for you to be approved for a loan. And if you are approved you will likely have to pay much higher interest rates.
What impacts my credit score?
The credit bureaus look at multiple factors when determining your score and will update them monthly. That means there is always an opportunity to improve your score if you’re mindful about how you manage your debt. Key factors that influence your credit score, include your payment history, your credit utilization, the length of your credit history, types of credit and any recent credit inquiries.
How to improve my credit score
The main way you can improve your credit score is by reducing or paying off any debt you have. It can be helpful to create a budget with your outgoings each month and ensure you can pay any bills or outstanding balances on time.
But before you can borrow money you need to establish a history of borrowing money and show you can pay it back and manage credit responsibly. If you have never taken out a credit card or a loan, but intend on buying a home in the next few years, then you should start building your credit history as soon as you can.
Since the length of your credit history plays into your overall score, some lenders may not approve you for a mortgage until you’ve had at least a year’s worth of credit history. So while it may sound counterintuitive to borrow money when you know you’re going to be borrowing significantly more when you buy a home, your credit history is vital to establishing your score.
You may also consider taking out a secured loan, which allows you to borrow money backed by your own collateral. A secured credit card is a way of building your credit history but is typically funded by the amount you deposit.
If you are approved for a regular credit card, remember you do not have to spend the total credit limit available to you. In fact, according to RBC, “you want your ratio to be less than 30%, meaning if you have a credit limit of $5,000, you should have a balance no higher than $1,500.”
The benefit of managing your balances is two-fold: you will not pay any interest on balances paid before the due date and not maxing out your credit limit may be beneficial to your credit score.
If you are concerned about missing a payment, then most banks allow you to set up autopay for the entire balance each month. So as long as you don’t spend beyond your means, you can show you are responsible with your money and pay your bills on time.
Should I use a credit monitoring service?
In addition to tracking your credit score yourself, there are also credit monitoring services offered by credit bureaus and many financial institutions that can keep track of changes in your credit report on your behalf. By using this service, you can be notified of any new account openings or credit inquiries in your name so that you are alerted to any potentially fraudulent activity. There is often a charge associated with these services, but some financial institutions may offer it for free.
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