Mastering the art of understanding your credit score

Understanding your credit score is an essential skill in today's financial landscape. A credit score is a numerical representation of your creditworthiness, influencing your ability to secure loans, credit cards, and even rent an apartment. This score, typically ranging from 300 to 850, is calculated based on your credit history, including your payment habits, the amount of debt you have, and the length of your credit history. Understanding your credit score can open doors to better financial opportunities and help you make informed decisions about your financial future.

In this guide, we explore the components of a credit score and provide practical tips on improving and maintaining it. Learn how credit scores are calculated and actionable steps to take control of your credit.

Understanding credit scores

The significance of a credit score extends beyond just loans and credit cards. It can impact various aspects of your life. For instance, employers may check your credit score as part of the hiring process, and insurance companies often use it to determine your premiums. A higher credit score can lead to lower interest rates, saving you money.

Conversely, a low credit score might result in higher interest rates or even disqualification from obtaining credit. Therefore, understanding how your credit score is calculated and the factors influencing it is crucial for maintaining and improving your financial health.

Understanding credit scores is a fundamental aspect of managing personal finances effectively. A credit score is a three-digit number that lenders use to assess the risk of lending money to you. It reflects your creditworthiness based on your credit history, which includes factors such as your payment history, the total amount of debt you have, the length of your credit history, types of credit in use, and any new credit accounts or inquiries. The most common credit scoring model is the FICO score, which ranges from 300 to 850. A higher score indicates lower risk, leading to better loan terms and lower interest rates.

The components of a credit score are weighted differently. Payment history is the most significant factor. It includes whether you've paid your past credit accounts on time. The amount owed considers your total debt and how much of your available credit you're using.

The length of your credit history looks at how long your credit accounts have been active. The remaining factors, types of credit in use and new credit, each account for 10% and consider the variety of credit accounts you have and recent credit activity, respectively.

Understanding these components is crucial because they highlight the areas to focus on to maintain or improve your credit score. For instance, making timely payments and reducing outstanding debt can significantly boost your score. Keeping older accounts open and applying for new credit sparingly can also help. By comprehending how your credit score is calculated and what influences it, you can take proactive steps to manage your credit responsibly, leading to better financial opportunities and stability.

Why credit scores are important

Access to credit

A good credit score increases your chances of being approved for loans, credit cards, and mortgages. Lenders use your credit score to evaluate your creditworthiness and determine whether to extend credit. A higher credit score often means better terms, such as lower interest rates and higher credit limits, which can save you money over time.

Interest rates

Your credit score directly influences your interest rates on loans and credit cards. A higher score typically qualifies you for lower interest rates, reducing the cost of borrowing. Conversely, a lower score may result in higher interest rates or difficulty obtaining credit altogether.

Insurance premiums

Insurance companies may use credit scores to determine premiums for auto, home, and renters insurance. A good credit score can lower your insurance costs.

Employment opportunities

Some employers may check credit scores as part of the hiring process, especially for roles that involve financial responsibilities. While credit checks for employment purposes are regulated in some jurisdictions, maintaining a good credit score can be advantageous when applying for jobs.

Housing opportunities

Landlords and property managers may consider credit scores when reviewing rental applications. A higher credit score can increase your chances of securing a lease and may result in lower security deposits or better rental terms.

Utilities and services

Utility companies, telecommunications providers, and other service providers may check credit scores when determining whether to approve your application or require a security deposit. A good credit score can facilitate smoother transactions and potentially waive deposit requirements.

Financial stability

A good credit score reflects responsible financial behaviour and management. It demonstrates your ability to handle credit responsibly, which is beneficial for immediate credit approvals and long-term financial stability and planning.

Your credit history

Your credit history is a comprehensive record of your borrowing and repayment activities. It plays a crucial role in determining your creditworthiness and affects your ability to obtain loans, credit cards, and other financial products. Understanding your credit history can help you manage your finances more effectively and improve your credit score.

Your credit history is used by lenders, landlords, employers, and insurance companies to assess your financial responsibility and risk level. A positive credit history, marked by on-time payments and low debt levels, can help you secure loans with favourable terms, lower interest rates, and higher credit limits. Conversely, a negative credit history with missed payments, high debt levels, and public records can make it difficult to obtain credit and lead to higher interest rates and less favourable loan terms.

Credit scores vs. credit reports

Credit scores and credit reports are both essential elements of your financial profile, but they serve different purposes and contain different types of information.

Credit reports

A credit report is a detailed record of your credit history maintained by credit bureaus such as Experian, Equifax, and TransUnion. It includes information about your credit accounts, payment history, outstanding debts, and public records such as bankruptcies or liens.

Credit reports also list inquiries made into your credit, such as those from lenders or potential employers. Your credit report provides a comprehensive overview of your financial behaviour and credit management over time.

Key components of a credit report include:

• Personal information: Name, address, Social Insurance Number, and employment history.

• Credit accounts: Details of your credit cards, loans, and other credit lines, including balances and payment history.

• Inquiries: Records of who has accessed your credit report.

• Public records: Information on bankruptcies, foreclosures, and other legal matters related to the debt.

Credit scores

A credit score is a numerical representation of your creditworthiness derived from the information in your credit report. It is calculated using algorithms developed by credit scoring models, such as FICO or VantageScore. Credit scores range from 300 to 850, with higher scores indicating better creditworthiness. Lenders use credit scores to assess an individual's lending risk and determine loan terms and interest rates.

Factors influencing your credit score include:

• Payment history: Whether you pay your bills on time.

• Amounts owed: Your total debt and debt ratio to your available credit.

• Length of credit history: How long you've had credit accounts.

• Credit mix: Your credit accounts, such as credit cards, mortgages, and auto loans.

• New credit: Recent credit inquiries and newly opened accounts.

How credit scores are calculated

Understanding how credit scores are calculated helps you be aware of increases and decreases in your credit profile. While the exact formulas are proprietary and vary slightly between scoring models like FICO and VantageScore, they generally consider similar factors. Here’s a breakdown of how credit scores are typically calculated:

Payment history (35%)

This is the most significant factor in calculating your credit score. It reflects whether you have paid your past credit accounts on time. Late payments, collections, and bankruptcies negatively impact this portion of your score. Consistently making on-time payments helps build a strong payment history.

Amounts owed (30%)

Also known as credit utilization, this factor considers the total debt you owe and the ratio of your credit card balances to your credit limits. Using a high percentage of your available credit can signal to lenders that you may be overextended, which can negatively affect your score. Keeping balances low relative to your credit limits helps improve this aspect of your score.

Length of credit history (15%)

This factor looks at how long your credit accounts have been open. A longer credit history provides more data on your financial behaviour and is generally favourable. It includes the age of your oldest account, the age of your newest account, and the average age of all your accounts.

Credit mix (10%)

This considers the variety of credit accounts you have, such as credit cards, mortgages, auto loans, and retail accounts. A diverse mix of credit types can be beneficial as it shows you can manage different kinds of credit responsibly.

New credit (10%)

This factor takes into account recent credit inquiries and newly opened accounts. Each time you apply for credit, a hard inquiry is recorded on your credit report, which can temporarily lower your score. Opening several new accounts in a short period can also be seen as risky behaviour. However, soft inquiries, like checking your credit score, do not affect your score.

Considerations for your credit score

• Frequency of late payments: The more recent and frequent your late payments, the more they will negatively impact your score.

• Total debt amount: High levels of overall debt can lower your score, especially if it's concentrated in credit card balances.

• Credit inquiries: While hard inquiries can affect your score, their impact diminishes over time and usually only affects your score for a year.

• Public records: Bankruptcies, foreclosures, and other public records can negatively impact your credit score significantly.

Credit score ranges

Credit score ranges provide a framework for evaluating your creditworthiness and are typically divided into several categories. Credit score ratings represent your credit risk and help lenders, landlords, and others quickly assess the risk associated with extending credit or services. Here are the typical credit score ranges for the FICO and VantageScore models.

FICO score ranges

• Exceptional (800-850): Scores in this range are considered exceptional. Individuals with scores above 800 are highly reliable borrowers. They are likely to receive the best loan terms, including the lowest interest rates and most favourable credit conditions.

• Very good (740-799): Scores in this range are considered very good. Borrowers in this range typically qualify for better-than-average interest rates and have a good chance of credit approval.

• Good (670-739): Scores in this range are considered good. Individuals with good credit scores are acceptable borrowers. They qualify for various credit products and loans, though not always with the best terms.

• Fair (580-669): Scores in this range are considered fair. Borrowers in this range may have some difficulties obtaining credit. They may qualify for the credit, but likely with higher interest rates and less favourable terms.

• Poor (300-579): Scores in this range are considered poor. Individuals with poor credit are seen as high-risk borrowers. They may struggle to obtain credit and will likely have high interest rates and stringent terms.

VantageScore ranges

• Excellent (781-850): Scores in this range are considered excellent. Similar to the FICO score range, individuals will likely receive the best terms and lowest interest rates.

• Good (661-780): Scores in this range are considered good. Borrowers can expect favourable terms, although not as favourable as those in the excellent range.

• Fair (601-660): Scores in this range are considered fair. Individuals with these scores may find it more challenging to secure credit with favourable terms and might face higher interest rates.

• Poor (500-600): Scores in this range are considered poor. Borrowers with poor credit are high risk and may find it difficult to obtain credit or will likely have high interest rates.

• Very poor (300-499): Scores in this range are considered very poor. Individuals with these scores have significant challenges obtaining credit. Credit typically comes with the highest interest rates and most restrictive terms.

What is the average credit score in Canada?

The average credit score in Canada is around 680, typically in the 650 to 700 range. This range indicates that many Canadians fall into the "good" category for credit scores. Factors influencing the average credit scores in Canada include:

• Economic conditions: Economic stability and employment rates can influence credit scores, as people with steady incomes are better able to manage their credit obligations.

• Credit usage trends: The way Canadians use credit, such as credit card debt levels and the number of new credit accounts opened, can affect average scores.

• Financial literacy: Increasing awareness and education about managing credit can lead to improved credit behaviours and higher average scores.

What is a good credit score?

A good credit score is typically considered to be in the range of 670 to 739 on the FICO scale and 661 to 780 on the VantageScore scale. The lowest credit score in Canada is between 300 to 579 on the FICO scale and 300 to 499 on the VantageScore scale. A good credit score typically results in:

• Loan approvals: A higher likelihood of loan approvals.

• Interest rates: Access to more favourable interest rates, which can save. you significant money over the loan's life.

• Credit cards: Eligibility for credit cards with better rewards, higher credit limits, and lower interest rates.

• Renting property: Easier approval for rental applications, often with lower security deposits.

• Insurance premiums: Potential lower insurance premiums as some insurers use credit scores to determine rates.

• Employment opportunities: Some employers check credit scores as part of the hiring process, particularly for positions with financial responsibilities.

Who calculates credit scores?

Credit scores are calculated by credit scoring agencies or companies using algorithms developed by major credit bureaus and independent scoring models.

Credit bureaus

Credit bureaus, also called credit reporting agencies, collect and maintain individuals' credit information and use it to generate a credit score. The three major credit bureaus in Canada are Equifax, Experian, and TransUnion.

Credit scoring companies

These companies develop algorithms and scoring models used to calculate credit scores based on the data collected by a credit bureau. The two most well-known credit scoring models are:

• FICO: FICO scores range from 300 to 850, and the payment history, amounts owed, length of credit history, new credit, and credit mix are considered.

• VantageScore: The VantageScore scale ranges from 300 to 850 and considers payment history, age and type of credit, credit utilization, total balances and debts, recent credit behaviour, and available credit.

Managing your credit accounts

Managing your credit accounts effectively is essential for maintaining a good credit score and ensuring financial stability. You can get copies of your credit report from credit bureaus or your financial institution or use credit score apps to check your score. Here are some key strategies to help you manage your credit accounts.

Pay bills on time

One of the most important aspects of managing credit is paying your bills on time. Payment history is the most significant factor in your credit score, accounting for about 35%. Setting up automatic payments or reminders can help ensure you never miss a due date, which can prevent late fees and negative marks on your credit report. Consistently making on-time payments demonstrates reliability to lenders and positively impacts your credit score.

Credit utilization

High credit utilization can negatively affect your credit score, so experts typically recommend keeping your utilization below 30%. For example, if your credit limit is $10,000, try to keep your balance under $3,000.

Regularly check your credit reports

Regularly checking your credit reports can also help you manage your accounts effectively. It allows you to spot errors or signs of fraud early and dispute any inaccuracies promptly. You can obtain a free copy of your credit report from each of the three major credit bureaus annually.

Maintain long-term accounts

Maintaining long-term credit accounts is beneficial for your credit history. The length of your credit history contributes to your credit score, so keeping older accounts open can be advantageous, even if you don’t use them frequently.

Limit new credit applications

Limiting new credit applications is important because each new application results in a hard inquiry, which can temporarily lower your credit score. Only apply for new credit when necessary and try to space out credit applications to minimize their impact.

Manage different types of credit

Managing a diverse mix of credit types, such as credit cards, mortgages, and auto loans, can also positively influence your credit score. However, it's crucial to manage these responsibly and not take on debt unnecessarily.

Pay off debt strategically

Reducing overall debt levels and avoiding the closure of unused credit cards are also key strategies. Paying off high-interest debt first can improve your credit score, and methods like the debt snowball, paying off the smallest balances first, or debt avalanche, paying off the highest interest rate balances first, can be effective.

Avoid closing unused credit cards

Keeping unused credit cards open can help maintain a lower credit utilization ratio and contribute positively to the length of your credit history. However, if you decide to request a credit limit increase to help with credit utilization, make sure that the issuer performs a soft inquiry instead of a hard inquiry.

Communicate with creditors

Many creditors offer options like payment plans, deferments, or hardship programs that can provide temporary relief without severely impacting your credit score. By proactively managing your credit accounts through timely payments, strategic use of credit, regular monitoring, and effective communication with creditors, you can maintain a healthy credit score and ensure long-term financial stability.

Disputing inaccurate credit information

Disputing inaccurate credit information is crucial in maintaining a healthy credit score and ensuring your credit report accurately reflects your financial history. Credit report mistakes can lead to lower credit scores, affecting your ability to obtain loans, credit cards, and rental agreements.

Common inaccuracies to look for include incorrect personal information, accounts that don’t belong to you, incorrect account status, and duplicate accounts. Check for inaccurate credit limits, balances, or payment history. Document each error you find and gather any supporting evidence, such as bank statements or payment records.

To dispute inaccuracies, contact the credit bureaus that issued the report containing the error. Each bureau has a process for submitting disputes, typically online, by mail, or by phone.

Monitoring and freezing your credit

Monitoring and freezing your credit are proactive measures to protect against identity theft and ensure the accuracy of your credit information. By regularly monitoring your credit and freezing it when necessary, you can maintain greater control over your financial health and reduce the risk of unauthorized activity.

Credit monitoring

Credit monitoring involves regularly checking your credit reports and scores to detect unusual or unauthorized activity. It can help you spot potential identity theft or errors early, allowing you to take action before significant damage occurs.

Many financial institutions and independent companies offer credit monitoring services. These services can alert you to changes in your credit report, such as new accounts opened in your name, significant changes in your credit balances, or hard inquiries. Some services are free, while others offer more comprehensive monitoring for a monthly fee. Examples include Experian, Equifax, TransUnion, and third-party services like Credit Karma.

Many credit monitoring services also provide regular updates to your credit score. Significant changes in your credit score can be an early indicator of potential fraud or errors. Even if you use a credit monitoring service, it’s good to review your credit reports manually.

Credit freezing

A credit freeze, also known as a security freeze, restricts access to your credit report, making it difficult for identity thieves to open new accounts in your name. When your credit is frozen, lenders and other companies cannot access your credit report to approve new credit applications.

You should request a credit freeze separately from each of the three major credit bureaus. This can usually be done online, by phone, or by mail. You will need to provide personal information to verify your identity, such as your name, address, date of birth, Social Security number, and possibly some additional details. Once the freeze is in place, each bureau will provide you with a PIN or password. Keep this information secure, as you will need it to lift the freeze temporarily or permanently when you want to apply for credit.

A credit freeze does not affect your credit score, nor does it prevent you from obtaining your credit report. You can still use your existing credit accounts, but new applications will be blocked. If you need to apply for new credit, you can temporarily lift the freeze using the PIN or password provided. You can specify which bureau(s) to lift the freeze with and for how long.

How to get your credit report

Obtaining your credit report in Canada is a straightforward process and can be done through the two major credit bureaus, Equifax and TransUnion. Both bureaus offer a free credit report once a year. To request your report online from Equifax, visit their website and follow the instructions to access your free report. You provide personal information such as your name, address, date of birth, and Social Insurance Number to verify your identity. TransUnion also allows you to request your free credit report through their website by providing similar personal information for identity verification.

If you prefer to receive your credit report by mail, Equifax and TransUnion offer this option as well. To request your report by mail, fill out a request form available on their websites. Provide copies of two pieces of identification, such as a driver's license, passport, or utility bill, to confirm your identity and address. Mail these documents to the respective credit bureau’s address on the form. It typically takes a few weeks for your credit report to arrive by mail once the request has been processed.

You can also request your credit report by phone. For Equifax, call their customer service number, and follow the automated instructions or speak with a representative. You provide personal information to verify your identity over the phone. TransUnion also offers a phone request option. Contact their customer service number and provide information to confirm your identity. Your credit report will then be mailed to you.

Once you receive your credit report, review it carefully to ensure all the information is accurate. Check for errors such as incorrect personal information, accounts that do not belong to you, or discrepancies in your payment history. If you find any inaccuracies, contact the credit bureau to dispute the errors and request corrections. Regularly monitoring your credit report helps you stay informed about your credit status and can alert you to potential identity theft or fraud.

By obtaining and reviewing your credit report from Equifax and TransUnion, you can maintain a clear understanding of your credit history, identify areas for improvement, and ensure your financial information is accurate. This proactive approach to managing your credit can help you achieve better financial health and secure more favourable credit opportunities.

How accurate is your credit score?

The accuracy of your credit score is generally high, but it can be influenced by several factors, including the completeness and accuracy of the information in your credit report, the specific scoring model used, and the timeliness of the data.

Your credit score is based on the information in your credit report compiled by credit bureaus. If your credit report contains errors, such as incorrect account details, misreported payments, or fraudulent accounts, your credit score will not accurately reflect your true creditworthiness. Regularly checking your credit reports and disputing inaccuracies is crucial for maintaining an accurate credit score.

Credit scores can change based on new information reported to the credit bureaus. If there is a delay in updating your credit report with recent payments or changes in credit balances, your credit score might not reflect your current financial situation. Typically, lenders and creditors report updates to the credit bureaus once a month, so there can be a lag in reflecting recent financial activities.

Various scoring models, such as FICO and VantageScore, use different algorithms to calculate credit scores. While these models generally consider similar factors (payment history, credit utilization, length of credit history, new credit, and credit mix), they weigh these factors differently. Your score might vary between different models. Additionally, each credit bureau might have slightly different information, leading to variations in your credit score across bureaus.

Credit inquiries can affect your score, but the impact varies. Hard inquiries, which occur when a lender checks your credit for a loan or credit application, can lower your score slightly. However, multiple hard inquiries in a short period for the same type of loan are often treated as a single inquiry to minimize the impact on your score. Soft inquiries, such as checking your credit or pre-approval checks by lenders, do not affect your score.

Your credit score is also a reflection of your long-term credit management habits. Consistently making on-time payments, maintaining low credit utilization, and avoiding excessive new credit applications contribute to a more stable and accurate credit score. Sudden changes in your financial behaviour can quickly alter your score.

Do negative marks stay on your credit report forever?

No, negative marks on your credit report generally do not stay on your report forever. The duration that negative information remains on your credit report depends on the type of negative mark. Here are some common types of negative marks and their typical durations:

• Late payments: Late payments can stay on your credit report for up to seven years from the date of the missed payment.

• Charge-offs: Charge-offs for non-payment can remain on your credit report for up to seven years from the date of the charge-off.

• Collections: Accounts sent to collections can stay on your report for up to seven years from the initial delinquency date that led to the collection.

• Bankruptcies: Chapter 7 bankruptcies can stay on your credit report for up to ten years from the filing date, while Chapter 13 bankruptcies can remain for up to seven years from the filing date.

• Foreclosures: Foreclosures typically remain on your credit report for up to seven years from the foreclosure date.

• Tax liens: Unpaid tax liens can stay on your credit report indefinitely until they are resolved. However, paid tax liens can stay on your report for up to seven years from the date they were paid.

While these negative marks have specific time frames for how long they can remain on your credit report, their impact on your credit score diminishes over time as they age. Credit scoring models tend to give less weight to older negative information than more recent negative events. By understanding how long negative marks can stay on your credit report and taking proactive steps to improve your creditworthiness, you can work towards achieving a healthier credit profile over time.

Myths and facts about credit scores

Understanding myths and facts about credit scores in Canada can empower you to make informed decisions about managing your credit. By debunking common misconceptions and knowing the key factors that affect your score, you can take proactive steps to improve your creditworthiness and achieve your financial goals.

Myth: Checking your credit score lowers it.

A soft inquiry doesn't affect your credit score. Only hard inquiries from lenders can have a temporary impact.

Myth: Closing credit cards improves your credit score.

Closing credit cards can lower your credit score by reducing your available credit and potentially increasing your credit utilization ratio.

Myth: You must carry a balance on your credit card to build credit.

You can build credit by using your credit card regularly and paying off the balance in full each month. Carrying a balance does not improve your score; it can increase interest charges.

Myth: Income affects your credit score.

Your income isn't directly reported to credit bureaus or factored into your credit score. However, it may impact your ability to qualify for certain types of credit.

Myth: Only debt impacts your credit score.

While debt levels are important, your credit score also considers payment history, credit utilization, length of credit history, types of credit, and recent inquiries.

Fact: Credit scores range from 300 to 900 in Canada.

A higher score indicates better creditworthiness. Lenders typically consider scores above 650 to 680 as good or excellent.

Fact: You can access your credit report for free.

Canadians can request a free credit score report from KOHO simply and easily. You can also get one from Equifax and TransUnion once a year through AnnualCreditReport.com.

Fact: Credit scores are dynamic.

Your credit score can change frequently based on your financial behaviour, such as making timely payments, opening new accounts, or paying down debt.

Fact: Your credit report includes personal information.

In addition to credit accounts, your report includes details like your address, employment history, and any public records, such as bankruptcies or liens.

Fact: Negative information can stay on your report for years.

Late payments, bankruptcies, and other negative marks can stay on your credit report for several years, impacting your score.

Start your credit journey at KOHO

Achieving a perfect credit score is a demanding goal, but it is certainly attainable with dedicated effort. By establishing sound financial habits and practicing responsible credit management, you can steadily increase your credit score while making prudent financial decisions. KOHO offers accessible tools and expert guidance to assist you in this journey.

Our resources provide comprehensive support for budgeting, tools for monitoring your expenditures, and valuable insights into your credit profile. Whether it's through our virtual credit card designed for daily purchases, overdraft protection coverage for your accounts, or a high-interest savings account to earn interest and grow your savings, we are committed to supporting you at every stage of your financial path. We also have KOHO for business to help companies manage their finances.

Learn about our various plans for spending and saving and build your credit with KOHO today.