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You may have heard the term credit score before, but what the heck is it? And what are the different aspects that make up a good credit score? The first thing we have to cover is the two different types of debt:
Two types of debt
There are two types of debt that go into a credit report, which determines your credit score.
The first is instalment debt, like your student loans. With instalment debt, you have set dates every month where you make a payment. And once you pay off this debt, it’s gone for good. Think of it this way; once you pay off your student debt, you don’t owe any more money and you can’t access that money again.
The second type is revolving debt, which is like a credit card or a line of credit. If you pay off revolving debt then you have access to it again. There’s also a limit as to how much debt you can use.
What is a credit score
A credit score is 3-digit number between 300 and 850 that makes up part of your credit history. It helps lenders get a better idea of how you handle debt and, more importantly for them, if you’re able to repay that debt.
There are two credit reporting agencies in Canada: Equifax and Transunion. They generate a credit report based on all the debts that you have and then assign a number based on how you handle credit. The ranges can be found below:
| 300-599 | Poor |
| 600-669 | Fair |
| 670-739 | Good |
| 740-799 | Very good |
| 800-850 | Excellent |
Why do I need a good credit score?
A credit score is important when you want to borrow money. This could be for something like a house or a car. A high credit score will not only help you qualify for the loan, but it will also determine what your interest rate will be. The higher your score, the less you’ll likely have to pay in interest (which saves you money).
What factors make up a credit score?
There are 5 factors that go into making up your credit score, and each one has a different weight
1. Payment history (35%)
This means making your payments on time. It means that there’s money in the bank when an instalment loan payment comes out (like your student loans) and that you pay your credit card bill on time every month.
2. Credit utilization (30%)
This financial jargon refers to how much credit you have versus how much you’re actually using. You want to have a large gap between your credit card balance and your credit card limit. More specifically, you want to keep your balance below 70% of your credit limit.
For example, if you have a credit limit of $1000, you don’t want your balance to be higher than $700 before your credit card bill
Also notice that this makes up 30% of your credit score. Even if you make all your payments on time, if your credit card is at the maximum limit then your score will most likely be lower
This also refers to the different types of debt that you have. If you have 5 credit cards, your score will be lower because you have access to so much debt. Try to have 1 credit card, 2 at the maximum.
3. Credit history (15%)
Your credit history refers to how long you’ve had your credit. You don’t want to keep opening and closing credit cards; find one and stick with it. It’s an easy way to build your credit score because it simply refers to how long you’ve had your card.
4. Public Records (10%)
If you ever go bankrupt then your credit score will be affected even after you’ve paid everything down. This also refers to any items that you don’t pay back that eventually go to a collection agency. Make sure that you pay all the debts that you owe
5. Inquiries (10%)
An inquiry is whenever someone accesses your credit report. If you’re purchasing a car, or looking for a new credit card, these companies might run your credit report to understand your debt history. Watch out for websites that promise financing for cars or debt consolidation, because sometimes they hide the fact that they can pull your credit in the terms of service
Also important to note is that a payday lender will lower it more because they are viewed as risker companies. As a side note: never get a payday loan
How can I check my credit score?
There are many apps that give you an estimate of your credit score every month, one of them being Credit Karma. These companies run a soft hit, which means that it doesn’t hurt your credit score every month. However, this also means that the score they give you is an estimate rather than a direct indication of your score.