Road to Better Credit: Understanding credit scores
One of the first steps to improve your credit is understanding your credit score and what goes into determining it. In this post, the first of our four-part “Road to Better Credit” series, we’ll help you better understand the factors that affect your score.
When you apply for a loan, including a mortgage, the financial institution evaluates your credit history and your credit score. While lenders place a high degree of importance on individual credit scores, it is surprising how many people have no idea what their personal credit score is, or what factors impact their score.
In Canada, the consumer reporting agencies commonly used by financial institutions to review individual credit scores are Equifax and TransUnion. These firms collect the credit history of consumers as reported by various credit-providing institutions and details on other credit events such as liens and bankruptcies.
When you apply for credit, the lender contacts these agencies to review your credit history and uses that information to determine the risk of lending to you. Factors that go into determining your credit score include:
Past payment history
As you would expect, past payment history is seen as an important indicator of future behaviour. Past payment history is one of the most heavily weighted factors used to determine your credit score. If you have a less-than-ideal record of paying bills on time, you can expect this to be reflected in your credit score.
Typical credit use
The ways in which you typically use the credit that is available to you also weighs heavily on your credit score. For instance, if you allow your balances on multiple credit accounts to hover near the credit limit, this may ultimately lower your credit score.
Types of credit
Many types of credit may appear on your credit report, and the impact each credit type has on your score varies. Debt types include personal loans and car loans, lines of credit, and credit cards.
Surprisingly, student loans do not impact your score even though details for these loans may appear on your credit report. However, be aware that nothing is preventing the lender from deciding that, even though your credit score may be quite good, a default on a student loan or missed mortgage payments makes you a greater risk.
Lack of established credit
Finally, a lack of established credit can also hurt your score. Admittedly, this is not necessarily your fault. Still, without a track record of successfully managing credit, it is difficult for a lender to make a well-informed decision about your ability to manage debt. In part two of our “Road to Better Credit” series, we talk about establishing credit using a secured credit card.
Using credit wisely
As you can see, several factors can affect your credit score, and it’s essential to understand how credit scores work when you plan to apply for a mortgage. The next post in the “Road to Better Credit” series will explain why you should avoid applying for more credit than you need.
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