Credit 101: Understanding Your Credit Score
Understanding credit is a large part of the dreading adulting we have to take part in everyday. Your credit score plays an extremely large role in achieving overall financial wellness. Understanding your credit score and what’s on your bureau, what it means, how it’s calculated and learning practical strategies to improve it, will definitely help you in so many aspects of your financial life. Your credit score has a direct impact on interest rates, access to new credit, housing; ability to rent or qualify for a mortgage, employment opportunities, and even your personal relationships.
Below I will share some information that will help you understand what components directly impact your credit score and some tips on how to improve your credit. Let’s get started!
1. Check your credit report: Many people do not even know what their credit score is, let alone what’s on their report. Sometimes when someone has a similar name as you the reporting agencies may include derogatory information that doesn’t even belong to you on your report, which can adversely effect your score. Most of the banks use Equifax to pull credit reports, so I highly suggest requesting a copy from there. It’s simple and easy and can be done online. Go through the report thoroughly and make sure everything is correct (i.e. full name, DOB, SIN/SSN, address, employment information, etc). Then check the public records and all the reporting credit trades and make sure all the account numbers match and these trades actually belong to you. If you notice anything that doesn’t look right or is in fact incorrect, call Equifax and have these items disputed and corrected immediately.
2. Payment History (35%): The largest portion of your score is depicted by your repayment history - at a whopping 35%. If you’re a few days late on payments once or twice you have nothing to worry about. The credit bureau only reports how many times you have been late past 30 days, past 60 days, and past 90 days. Also remember that if you have a cell phone in your name, this will show up on your bureau as well.Written off accounts, collections, and judgments all have a negative effect on your score and when lenders see this they will assume you are a higher risk borrower. This will result in 1) being unable to qualify for credit 2) creditors requesting for a co-signor/guarantor 3) Much higher interest rates.
Pay your debts on time.
WHAT CREDITORS REALLY WANT TO KNOW IS:
Are you consistently paying your bills on time?
Do you frequently miss payments?
How many times have you missed a payment?
How old are your missed payments?
It’s also important to note that there are two important dates when it comes to paying off your card – the due date and the statement date. The statement date is when your card issuer reports the balance to the bureau. If you pay off the balance in full before the statement date, it will report as 0 balance on your bureau. This will impact your score tremendously because creditors will see it as you are not reliant on credit and are able to pay what you have borrowed in full.
3. Debt Load/Utilization (30%): Don’t max out your cards! I repeat, do not max out your cards! If you have a $5000 credit limit and you max out the card to the full $5000, it’s basically credit suicide, especially if paired with other poor credit habits. By the time your statement comes and the minimum payment and interest charges are added, it will send you over balance owing over the actual limit. This has a detrimental impact on your score, especially when you are maxed out on multiple trades. It’s also a sign to the lenders that you are over leveraged and have borrowed more than you can pay back.
A rule of thumb would be to keep the balance on your cards at no more than 30% of the limit. I would also suggest paying off your balance in full frequently as this is also impacts your score positively and saves you in interest.
4. Length of Credit History (15%): There is literally people out there who have no credit history at all. And though I totally understand why, it actually works against you in the long run when you do need credit. Imagine this: you have never had a loan, credit card, line of credit, nada! You believe in a cash only lifestyle. You are now looking to purchase a home, so you go to the bank. They see that you have never had any credit products in the past and now they are having a hard time assessing what your ability to pay back debts is like, seeing that you don’t have any experience with any. A score of zero is almost like having a score of 500. Creditors see you as more of a risk and will ask for co-signors with an established credit to borrow with you in case you default. Creditors generally like to see credit history of at minimum 2 years or older, anything under is classified as a Thin Credit File and you may have a harder time trying to borrow for larger scale items like cars and mortgages. A longer, properly managed, credit history demonstrates to lenders that you have been able to manage and utilize your credit in a sufficient and responsible manner.
5. Inquiries (10%): Don’t open a new phone plan, finance a car, submit a mortgage pre-approval, and apply for a credit card all within a month. Lenders see this as a sign of financial instability and a reliance on credit. A lot of the time, people’s scores are impacted when they are shopping around for a good mortgage rate or even good rates to finance a vehicle. So be mindful of how many inquiries you are making, as going overboard can have an effect on your score.
6. Types of Credit of Used (10%): Different types of credit generally show creditors how you are able to manage your finances overall. This is where term reducing versus revolving credit comes along. Term reducing credit includes things such as mortgages, car loans, student loans, and personal loans. These types of credit products have a specific amount of time in which the credit must be paid (amortization/term) and once the funds are used, they can not be re-used. With revolving credit (i.e. credit cards, line of credits, home equity line of credits) repayment is more flexible to customers (minimum payments, fixed rate advantage options, 1 % of balance options, etc.) and once it is paid back, is it available for use again. People tend to get into a lot more financial trouble with revolving facilities.
I was one of those people. When I was in university, I had four credit cards that were all maxed out. I had used the cards to pay for tuition when I was not funded enough by OSAP. I only made the minimum payments on these cards because that was all I could afford at the time. They were all over balance due to interest and minimum payments. Though I never missed any payments, this left me with a score of 640. Once I learned about credit and how it works, I decided to go to my bank and apply for a consolidation loan. I was approved and I used the funds from the loan to pay off all four of my credit cards and I closed two of them (I kept my other two oldest cards and they would contribute to the length of my credit history). Within three months I checked my score again, and I had gone from a 640 to a 727 just by switching out those revolving debts for a term reducing debt. In another 3 months, I had reached a score of 758. Not to mention, I went from paying 21.99% interest on 4 different cards, to 2.7% on my one loan. With some strict budgeting, I paid off that consolidation loan two years earlier that the set term and I am now free of that debt that was haunting me.
Getting your credit under control really takes discipline and patience. Set up financial goals for yourself and stick to them, and I guarantee you will yield results! I hope that in some way you have found this helpful and if you have any questions please feel free to reach out to me and I’d be glad to help in anyway that I can.
Thanks for reading!
-Dej!
