Understanding and Keeping Your Credit Score Healthy

One of the least understood financial tools that a consumer has that affects their ability to borrow and at what rate is the credit score commonly known as the beacon score. This is a number that is assigned to you based on various criteria that a lender looks at to see if you are an applicant that they consider being financially able and credit worthy to repay a loan or mortgage.

In Canada there are 2 credit rating bureaus – Equifax or Transunion. Each has their own scoring system and they may or may not contain the same financial information. Equifax has a number system from 300 to 900. A number above 700 is considered good while a number in the 300-400 range is very poor. Prime mortgage lenders look for a number from 620 to 650 to consider a candidate. There are alternate or “B” lenders that will go as low as 500 and private lenders do not look at the credit score.

The  credit score is made of 5 different components:

a)     Payment history          35%

b)    Debt amount               30%

c)     Credit history               15%

d)    New credit accounts   10%

e)     Types of credit              10%

As a consumer you must give your written consent first before an inquiry can be made. ie: mortgage application, credit card application.

You can receive a free report from either agency so that you can check it for accuracy and any misinformation. You will not receive the actual number unless you pay to receive it.

Your credit score can be negatively affected by too many inquiries in a relatively short period of time ie: you apply for 3 different credit cards in a short period of time. Each application will count as a “hard hit” and each hit can lower your score by 7 points.

An exception is the agencies realize that if you are shopping for a new mortgage or car several inquires may be made. As long as they are made in a short time period – 2 or 3 weeks- they will only count as 1 hit.

If you ask for your report or an insurance company does this will be considered a “soft hit” and will not affect your score.

If a person runs into financial problems and an account goes to a collection agency this will stay on your report for 7 years. As long as you start to show that you are re-establishing credit and making your payments on time, there are lenders that will grant you a mortgage but at a higher rate. Generally they look for 2 years of good re-established credit.

If your credit score has taken a hit you can bring it back up over a period of time. Some of the suggested ways include:

a)     Pay your bills on time so that your payment is received before the due date.

b)    Reduce your total debt. It is suggested that you try to keep your debt level at 30-40% of your total credit ceiling. This is called your debt utilization level. Try to pay down those loans that have the highest interest rate first.

c)     Try to build a credit history. Most lenders look for 2 trade lines ie: major credit cards and/or lines of credit.

d)    If you have an old credit card with no balance and you are not using it your first impulse might be to cancel it. However the length of time you have a card affects your score and cancelling it could have a negative effect along with affecting your utilization level. An example. You have one credit card with a $2000 limit and owe $1000. You have another card with no balance and a limit of $3000. You owe $1000 with a total limit of $5000 and you are using 20% of your limit. If you cancel the one with a $3000 limit you now owe $1000 with a limit of $2000 so you are now using 50% of your available credit. This would signal a red flag to a flag.

 

In summary, use any credit cards or lines of credit wisely and keep your credit rating healthy.