Having a good credit score can open doors to lower interest rates. But raising your score requires knowing some counter-intuitive rules
Having a solid credit history with a good credit score can open doors to lower interest rates and other benefits. But what exactly is a credit score and how can you improve it if it’s lacking?
A credit score is a three-digit number that lenders use to assess your credit worthiness. The lower your score, the riskier you’re considered. There are a variety of credit scores that use different formulas. Canadian credit scores range from 300 to 900 points and are produced by lenders and credit reporting agencies under different brand names, such as Beacon and FICO.
The exact formula that a credit bureau applies to calculate your score is a closely guarded secret. But the Financial Consumer Agency of Canada (FCAC) says top factors include your payment history, the percentage of your available credit that’s in use, the length of your credit history, the types of credit you have used and the number of credit inquiries on your record.
Canadians who don’t clearly understand credit scores often sabotage their own rating. “On a daily basis we talk to people trying to raise their credit score who in fact end up lowering their score,” commented Sheldon Wolf, president of credit repair agency Canada Credit Fix, in an email interview.
Sometimes the rules of the game seem counter-intuitive. If you’re working on raising your credit score, keep these points in mind:
1. Improving your credit utilization ratio can boost your score more than full repayment.
Your credit utilization is a measure of how much of your available credit you’re actually using. It’s the second most important component of your credit score, after credit history. You can improve this ratio by either increasing your credit limits — often either not possible or not desirable — or lowering your credit usage.
Wolf says maxing out your credit card is particularly damaging, even if you pay off your balance every month. “Depending on the date your account balance is reported to the credit bureau, your credit score may be negatively impacted for up to 90 days, despite the fact you paid off the full balance,” explains Wolf, who adds that a balance exceeding 70 per cent of the account limit will cause your credit score to plummet. The FCAC recommends that accountholders keep their percentage of outstanding debt to below 35 per cent at all times.
2. Mortgage or rent payments won’t raise your score.
Mortgage debt is generally not reported to the credit bureaus, even though you need a good credit score to qualify for the best mortgage rates. Credit score calculations also exclude rent payments, despite the fact that many landlords insist on seeing applicant scores. “Rent is a prepaid expense and not \u2018credit’ as defined by the lending industry,” says Eric Putnam, Managing Director of Debt Coach Canada. “Landlords simply ask for credit reports to limit their risk of default.”
3. Canceling old credit cards can shrink your score.
After taking out a consolidation loan and shutting down high-interest card accounts, some consumers assume they have automatically rehabilitated their credit rating. While that strategy may help you save on interest costs, canceling cards can actually damage your credit score. That’s because the length of time you have successfully held credit accounts is an important part of your score. The longer an account is reported the better it is for your rating.
“Closing credit cards after paying them off may impact your score negatively if they are the oldest accounts you have,” comments Putnam. “The consolidation loan will be [considered by Equifax and TransUnion as] new credit, and also will report as a high ratio balance-to-loan amount.” This can lower your credit score even more.
4. Credit bureau scores can vary significantly.
Some Canadians are unaware that they may have sharply different scores, depending on the credit reporting agency. Canada Credit Fix’s Wolf points out that Equifax’s calculated score frequently doesn’t match TransUnion’s numeric assessment for the same person.
“To make matters even more complicated for the consumer, often the credit score they receive on their purchased credit report will also differ from those acquired by lenders.” This can happen because the lender may order a different type of credit score to assess a particular type of risk, for instance to see if you qualify for a mortgage.
5. Tiny unpaid balances can ruin your score.
Consumer advocate Ellen Roseman reported in her Toronto Star column that a reader’s credit score was slashed due to a delinquent store card debt amounting to just 3 pennies. As a result, that person had to pay almost double the mortgage rate for a loan from a secondary lender, and also couldn’t qualify for a line of credit.
One lesson from this example is that consumers are responsible for ensuring that their credit reports are correct, even for seemingly trivial amounts. Credit bureaus such as Equifax and TransUnion handle billions of data bits from hundreds of lenders and service providers. “It would be close to impossible to ensure that all information is accurate prior to the items being displayed on the credit report,” says Sheldon Wolf.
6. Even rich people need to monitor their scores.
Wealthy individuals with privileged access to credit often attract extra attention from criminals. “When identity theft and credit fraud occurs, people with the best credit are the biggest targets,” comments Wolf. It’s important for all consumers to keep an eye out for mistakes.
“Absolutely no one is safe from errors,” says Wolf. “We had one client who had a collection on his credit report which simply was not his debt. Meanwhile, American Express rolled back his credit card limits by $30,000 due to the wrongful dropping of his credit score.”
7. You don’t need a perfect score.
Experts agree that a perfect credit score of 900 is extremely difficult to attain.
The good news is that you don’t have to have the highest theoretical rating to qualify for the lowest borrowing rates. In his book Crushing Debt, chartered accountant David Trahair presents a table showing that a credit score of 811 qualifies for the same attractive interest rates as does the impeccable 900 level.
Still, consumers should conscientiously strive to polish their scores. Trahair’s book also reveals how consumers in the top credit score category (811 to 900) can save $47,500 on a $100,000 loan over 10 years compared to borrowers in the lowest tier (180 and below).