How does credit score work?
Our credit score is a numerical representation of your financial standing. It computes various factors in your financial life.
Creditors report your credit history to TransUnion Canada and Equifax Canada. Any credit you incur starts from day 1. Usually, transaction history gets reported on a monthly basis. You often see an R or an I. This indicates the type of loan you have. The information available to the reader is not visible to everyone. A creditor can dictate to the credit agency what to show and what not to show to the inquirer.
Banks have their own internal score as well when they are evaluating an application. Therefore, make no mistake, that a credit score is not all you need when applying for a mortgage or any type of credit. Here is a quick overview of what your score means, especially if you are wondering what is a good credit score:
760 to 900 = Excellent score and can qualify for low-interest rates
725 to 759 = Very Good score
660 to 724 = Good credit score
560 to 659 = Fair score
300 to 559 = Poor score and needs a lot of work
If you notice, the higher your credit score, the better and easier to qualify for a mortgage. When you make financial mistakes, your credit score decreases. This reflects your current situation. The method of any computation is not disclosed to the public. FICO uses five main criteria to get a close approximation of your financial status. These are the following:
Loan Repayment History
This accounts for 35% of your score, making this, one of the most important component of your score. The balances you carry, have a lot to do with how you meet your payment obligations. All credit history, including proposals and bankruptcies. Sometimes, the consumer does not check and this will stay on the credit report forever.
This looks at how you have been meeting your financial obligations. It will reflect if you have been paying or if you have been missing your payments. The most important factor in your credit score focuses on identifying if you are paying on time or not. This helps lenders assess the risk they are taking on when you evaluating a loan application. This will also be a consideration of the interest rates you will qualify. If you have been paying on time, there is a good chance that you will do the same with them.
Total amounts owed
This accounts for 30% of your credit score. It looks at the amount you owe to the lenders as reported to the credit bureau agencies. This gives them an idea of your balances. It paints a pretty definite picture if you are stretching out your finances too thin.
You might come across a more technical term called debt-to-credit ratio. Creditors must assess our balances and the credit limits we carry. Creditors can conditionally close your credit cards when you get debt consolidation. We are going back to the days when this used to be a constant basis. If you are consolidating to make your payments easier, you could reuse the credit. This is the creditor rationale.
Length of Credit History
Another factor in computing your credit score is your credit history. This makes 15% of your total score.
If you have never borrowed, you don’t have a history reported. This could present a bit of a problem to the lender.
Lenders cannot assess a risk if you do not have a score. It is important to start building your credit history as early as possible. You can start building your credit score even while you are in college.
Some people who are new to Canada may qualify for a mortgage without a credit score. This is because, when people are immigrating to Canada, they do not usually have a credit history yet. Banks are aware of that and do not put emphasis on the credit.
In some cases, it is a very good idea to get a secured card; this way, you start building a credit history. This will make it easier to qualify when applying for a mortgage. You may contact your broker and get some guidance on how to do this.
It goes without saying that you need to take care of your old accounts such as credit cards you took out years ago. The longer you have them, the more transaction there are on cards given the use. But, you also need to make sure that your credit history reflects positive habits. You need to make sure that you are making payments every time without delays. A valuable tip I give to my prospects is to set reminders a couple of days before the payments are due. In our busy lives, it is very easy to forget, this could be costly! We have at our disposal a wonderful technology that can remind us, let’s use it. This way there is no chance of forgetting to make payment house and thus risking to have a bad credit.
This makes up 10% of the total weight. One of the elements of your credit score is looking at the frequency of your credit applications. When you apply for any type of credit or loan, the potential lender performs a “hard inquiry” on your credit. This is for the simple fact that they have to assess the risk factor.
As you do this many times over a short period of time, there will be several “hard pulls” on your credit. This can lower your score. This is because lenders might think that you are in some form of financial trouble and would make you a risk. That is why your score dips down a few numbers with several “hard pulls.”
I would approach a mortgage broker. This pulls only 1 credit bureau and can present it to several lenders when applying for a mortgage. It is better to be safe than sorry. Mortgage brokers, have many options available and will work in your best interest.
Types of credit
Although it only consists for 10% of the total weight, this is also part of your credit score. The idea is to have a good credit mix .
Great tips to protect your credit:
Try to carry balances only on 1 credit card.
Keep your balances low.
Take a look at your budget. It’s a lot of discipline, but “we reap what we sow”.
What you need to look out for. Opening several accounts to build a history, can be detrimental. Lenders will perform “Hard pulls”. Remember that this will lower your score as well. Stagger your applications. A hard pulls is when a lender makes an inquiry while you are applying for the loan. This gets reported to the agency.
What I usually recommend is not to apply for more than 2 credit cards or lines in any given time.
One thing to remember, do not take out more credit than you need. This will show that you are spreading yourself too thin and shows signs of troubles.