Your credit score is a number that affects your capacity to obtain a new loan, as you probably already know. However, if you have bad credit, trying to raise it can be a frustrating endeavour. By understanding how Canadian credit bureaus determine your credit score, you may positively manage your credit behaviour and be eligible for traditional credit, such as a mortgage or vehicle loan, at a competitive interest rate.
The five elements that determine whether you have a good or terrible credit score are covered in this tutorial, along with the most frequently asked questions we receive as an insolvency trustee company concerning what influences your credit score and what doesn’t.
Summary of Contents
- The five key components of a credit score
- What boosts your credit rating?
- What lowers your credit rating?
- What other factors do lenders consider before granting new credit?
- Six credit score fallacies you should know
The five primary determinants of a credit score
A credit rating is a number that gives lenders an idea of the risk associated with extending credit to you. This score is calculated by a credit report that contains your payment history on loans, credit cards, and some bill payments. It keeps track of account opening and closing dates and whether payments were made on time, late, or sent to collections.
Two credit bureaus in Canada, Equifax and TransUnion, handle monthly updates to your credit history.
Although credit-scoring businesses use a complex mathematical formula to determine your score, their contributing variables may be divided into five groups.
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History of Payments
Your payment history, which makes up 35% of your credit score, is the most crucial element you have influence over. Your credit score will be lowered by even one late payment. The severity of the penalty for late payments increases with your credit score. Your credit score may soon improve if you don’t make any additional late payments, but making numerous late or missed payments will severely harm your credit.
Late payments can remain on your credit report for up to six years, though they have less impact than more recent late payments.
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Credit usage amount
Your debt-to-credit ratio, also known as credit utilization, is determined as the amount owed on your accounts divided by the total amount of credit you have access to (your credit limit). A higher credit score is correlated with a low credit use ratio. A third of your credit score is also determined by how much credit you are using.
Lenders will assume you are a high-risk borrower if you have credit cards or lines of credit at their maximum limits. Near-limit accounts indicate to lenders that the borrower is probably living beyond their means. You will have a better credit score if you don’t use it even close to your credit limit.
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Credit period
Potential lenders can realize you have experience managing credit based on how long you have had a credit card account or line of credit. It’s best if you have a credit account for a while. Lenders prefer to see a long history of timely borrowing and repayment. An excellent credit score is produced by maintaining long-term credit accounts in good standing.
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Fresh credit
Even if having credit is necessary to build a good credit rating, you should only open new accounts occasionally. Long-standing credit accounts benefit your score, but recent debt can have the opposite effect.
Multiple credit inquiries, loan applications, and shopping around for new credit will show prospective lenders that you might be a high-risk borrower. Your credit report’s average length of credit history will also be shortened by opening new credit cards and cancelling accounts often.
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A healthy combination of credit
You will gain from borrowing less than someone with an excellent credit mix if you only have one credit account, even if you regularly pay your credit card bill on time and try to avoid using it to the maximum. If you want a strong credit rating, you must demonstrate a history of managing many credit accounts. Your credit score can be boosted by having open accounts such as installment loans like car loans, credit cards, and lines of credit.
Nevertheless, based on our experience, having even two credit cards with a reasonable credit limit will assist you in raising your credit score. If you have filed for bankruptcy or a consumer proposal and wish to rebuild your credit, you must open new credit accounts over the course of several months. To be eligible for a low-rate mortgage or term loan, most traditional lenders require you to open two new, active accounts with a minimum credit limit of $3,000 each and maintain a three-year solid payment history.
What boosts your credit rating?
You can take a variety of actions to raise your credit score. However, you’ve just made the first step by understanding how credit ratings are determined. Additionally, we advise checking the accuracy of your credit report as least once a year. You want your score to be determined using accurate data.
To get your free credit report, visit the credit agencies’ websites or give them a call.
Pay bills promptly.
Paying your bills on time is the best way to raise your credit score. Everyone experiences unforeseen life occurrences, therefore here are two strategies I advise to keep you on top of your bill payments:
- Automate your bill-paying processes to avoid forgetting to make a payment.
- Instead of using credit, you can’t afford to repay, have a small emergency fund, say up to $1,000, to cover you when the unexpected occurs.
- When extreme financial troubles arise, keep in touch with your credit card holder or account holder. Ask whether they will give you a grace period if you know you will miss multiple payments because of sickness or lack of employment. Don’t wait until you are behind to reach out to an insolvency trustee because you will need to be in good standing with them.
Keep your usage low.
If you desire a high credit score, it’s generally recommended that you use no more than 35% of your available credit. Even if you pay off the entire balance each month, employing more than 35% of your available credit indicates to lenders that you are a high-risk borrower. High ratios have the same negative effect on your credit as failing to make a payment on time.
We advise keeping your utilization rate as near to zero as you can if you are trying to restore bad credit. You can achieve this by paying off your credit card as soon as you charge a purchase. As with a cell phone bill, we frequently suggest that our clients set up a single monthly payment and settle it as soon as the charge posts. This enables you to “use” your credit account while maintaining a zero balance.
Limit credit inquiries
While regularly checking your credit report demonstrates sound financial management, applying for numerous types of credit at once will lower your credit score. This indicates to potential lenders that you might be living beyond your means and using credit that you can’t pay back.
Ask the lender if they will make a hard or soft hit on your credit report if you are looking for a good deal. Your credit score is unaffected by soft inquiries, which are used for preapprovals or background checks. Hard questions are recorded on your credit history for three years and appear as formal credit applications.
Your credit score is unaffected by checking or obtaining your credit report.
Keep account closures to a minimum.
Is closing outdated accounts a smart idea for your credit score?
Living debt-free is an admirable objective that many Canadians are pursuing. Only close your account if you have paid off your debt. The ability to handle open credit accounts for an extended period raises your credit score. Your credit score will be affected if you close an account, even if there is no balance.
These debts will be listed as “included in bankruptcy” or “included in proposal” and closed if you have filed for bankruptcy or made a consumer proposal. As you rebuild, your objective is to create two new accounts.
Having a secured credit card
Will a secured card help you boost your credit score?
You can get a secured credit card if you need to repair your credit following an insolvency case and still need to be approved for a regular card. A secured credit card will impact your credit score since transaction activity is reported on your credit report like other credit card types. Your credit limit, debt due, and payments will be displayed monthly, which can help you establish a solid reputation for using credit cards responsibly.
Prepaid credit cards: Do they impact credit? Regrettably, since prepaid credit cards are not reported to credit bureaus, they have no impact on your credit score. Prepaid cards are more like debit cards because you preload money on them, so they are not a loan or borrowing mechanism.
What lowers your credit rating?
Given your knowledge of how to raise your rating, let’s move on to credit score elements you should steer clear of.
There are tiny variables that many Canadians overlook that might have a more significant influence on your rating than late or missed payments and large credit card balances. The top “invisible” behaviours to avoid that lower your credit score are listed here.
Late payments for services or utilities
Any business that reports payments to the credit bureaus impacts credit scores. Your credit report in Canada contains information on your service accounts, including those for your cell phone, landline phone, cable, and internet.
Because these payments are so small, paying your cell phone or internet bills on time won’t typically increase your score. On the other hand, a late payment on a service account will harm your credit just as much as a late payment on a credit card. So, keep all your tabs up-to-date to avoid damaging your score.
Remaining fines
The province or municipality can send these kinds of fines to collections if you don’t pay a fine or traffic penalty. If the collection company wishes to, they can report the amount outstanding, and it will appear not as a fine but as an account in collection.
Similar to 407 ETR debts, unpaid fees may appear on your credit record if they are turned over to a collection agency.
Inform the ticketing organization when you get a fine or cost. You may be able to argue for a reduced amount, a payment plan, or for the cost to be waived. Deal with it, in any case, to prevent the fine from being sent to collectors and harming your credit report.
Mistakes in credit reports
Credit reporting organizations receive data from lenders; regrettably, errors are frequent. Simple things like your address, name, phone number, or job history won’t impact your credit score, but they could make it more difficult for lenders to verify your identity. Other inaccuracies on your credit report, such as incorrect balances, inaccurate negative information, information that has not been removed when it should have, or improper payment history, can hurt your credit and lower your score. To ensure accounts are being reported accurately, we advise examining your credit report at least once a year.
Federal debt
The Canada Revenue Agency recovers back taxes and unpaid Canada Student Loans.
Since tax debts are not reported to credit bureaus, they often have no impact on your credit score. The only exception is if CRA receives a court decision that will be included in the public record section of your report.
Your payment history and Canada Student Loan payments are typically reported to the credit bureaus. Falling behind on your student loans can harm your credit score.
Identity theft
To prevent identity fraud, it is essential to take the time to obtain your free annual credit report. As a result of loans being outstanding in your name that you are ignorant of and didn’t authorize, identity theft is on the rise in Canada and can harm your credit score. Take charge of your financial history by keeping an eye on what appears on your report, and challenge any shady transactions or credit requests before they do long-term harm.
What other factors do lenders consider before granting new credit?
While your credit score is crucial when applying for new credit, financial organizations will also consider other factors when evaluating your loan application. Lenders will consider the following:
- The level and consistency of your income,
- Your debt-to-income ratio at the moment,
- Any resources you can use as security,
- Your credit ranking
- You need to be aware of six credit score fallacies.
Myths regarding credit scores:
Many Canadians hold common misconceptions about credit ratings and credit histories. Top credit score myths include the following:
Myth: Declaring bankruptcy precludes future credit access
One way to reduce your mountainous debt is to file for bankruptcy or make a consumer proposal. Although these procedures temporarily restrict your credit options, they won’t prevent you from obtaining credit in the future.
Your credit report will be a good record that you filed. Credit reporting services have retention guidelines for how long your bankruptcy or proposal will be listed on your credit report, much like with late payments:
Myth: Your credit report will reflect a bankruptcy for six to seven years after filing.
According to the websites for TransUnion and Equifax, proposals will be deleted three years after completion or six years after the submission date, whichever comes first.
There is no information about your monthly bankruptcy or proposal payments on your credit report, and your credit score is unaffected. The credit bureaus receive no information from Licensed Insolvency Trustees. The Office of the Superintendent of Bankruptcy handles the information regarding your bankruptcy or proposal. They will detail your default or consumer proposal status, filing date, and completion or discharge date.
When your bills and credit history become too much for you to bear, taking action to start over by filing for bankruptcy or making a proposal will help you deal with your debts, allow you to restore your financial health, and help you begin the process of rebuilding your credit.
Myth: Increasing your credit limit is always a good idea.
Your credit score and general financial health will be affected positively and negatively by raising your credit limit or accepting a pre-approved credit limit increase.
While greater limits can help you keep your debt at 35% or less of your available credit and lower your credit usage rate, they can also negatively affect your credit score by allowing you access to more debt if you can’t manage your balances.
Raising the limit may initially harm your score if you’ve recently applied for other loans because the lender may also require a complex investigation. Ask the lender if they would perform a hard hit once you accept, even if your credit limit has already been increased.
Last but not least, even if you have a good credit score, a new lender could reject your application if they believe you already have too much credit accessible, even if you have a lot of available credit.
Applying for credit should only be done when it is necessary.
Myth: Couples’ credit ratings are shared
In Canada, every borrower has a unique credit score. It won’t impact the other partner’s credit score if one partner has bad credit or needs financial assistance, such as when filing for bankruptcy. If a debt is joint or co-signed, only that person’s credit may be impacted.
Myth: Repaying your auto loan will lower your credit score.
When you pay off a term loan, such as a car loan, the account will be closed because you have completed the required number of payments for the loan’s duration. Upon payment in full, closed accounts will be removed from your report ten years after the final reporting date.
While paying off your auto loan won’t necessarily lower your credit score, having a record of on-time monthly car loan payments will assist if you are trying to repair your credit.
Myth: Loans for credit restoration can raise your credit score
Numerous companies offer to set you up with affordable monthly payment schedules, claiming that doing so can help you rehabilitate your credit. They plan to inform the credit bureau of these monthly payments.
In truth, most credit restoration programmes function differently than stated. They can negatively influence your credit report if you miss a payment, not to mention the charges connected with these loans.
Myth: Income and assets can raise your credit score
Most people are surprised to learn that your income and assets do not affect your credit score. A person with a higher salary can have a higher score, mainly because they can afford to maintain low balances and qualify for a higher credit limit. There is no consideration for their income. Similarly, having equity in your property does not boost your credit score.
Your chances of being approved for a new loan might increase your income and the assets you put up as security. In addition to your credit score, a lender will consider these other variables while reviewing your loan application.
If you are in Ontario and looking for assistance with managing debt, Dana Trustee can help. We have years of experience as an insolvency trustee, and we can advise on improving your financial situation and getting back on track. We will work together to find the best solution for you and your family to start rebuilding your credit score today! Contact Dana Trustee today for guidance and support.