What is credit? And, more importantly, why is credit important to you?
If you google “What is Credit?”, the first answer you’ll see is:
(noun)The ability of a customer to obtain goods or services before payment, based on the trust that the payment will be made in the future.
So, we now know the basic idea of what credit is, but how does apotential creditor determine if you are a good borrower? They use the
5 C’s of Credit:
Let me break these down into simple explanations:
Simply put into a sentence, we ask the following: “Do you have the integrity (character) to do what you said you would do and repay what you have borrowed? Did you repay the debt under the terms (conditions) that were agreed upon between yourself and the creditor?
Did you stay within the limits of the agreed upon debt, or did you exceed the boundary (capacity) and over-extend yourself? Did you leverage all of your assets (collateral) to obtain the debt and do you have any funds (capital) left over in order to get yourself out of debt?”
The credit reporting agencies, Equifax and TransUnion, use a mathematical formula created by Bill Fair and Earl Isaac in 1956. Fair and Isaac created a score called the FICO (or Beacon) score, which is a measure of consumer credit risk. This formula takes into consideration all of the C’s of credit and makes it easy for potential lenders to see at a glance if the applicant is a good credit risk or not. Equifax and TransUnion will calculate the numbers from the credit report and generate a number ranging between 300 (being the worst possible score) and 900 (being the proverbial pot of gold that you can never quite reach).
A low score indicates a bad risk. A score of 700 or more usually puts the applicant in the lenders’ good books and gives the applicant access to the best possible rates and terms available.
So, knowing all of this, what can you do to make yourself look pretty to the creditors? Let’s take a look at how scores are calculated:
bankruptcies, late payments, past due accounts, wage garnishments, collections, judgements, consumer proposals. Purged after 7 years from date of last update by creditor
proportion of balance to total credit limit; the tighter the ratio, the lower the credit rating
|Length of Credit History
accounts are considered to be mature after they have been actively reporting to two full years
shopping for credit and newly opened accounts may reduce your score
|Types of Credit
having various types of credit can have a positive affect on your score, whereas having all of the same type (ie just credit cards) may reduce it
How to improve your credit rating:
1. Order a copy of your credit report yourself, prior to allowing any 3 rd party to view it. You may do so online at www.consumer.equifax.ca or www.members.transunion.ca
Review the report carefully to ensure there are no errors.
2. Pay all bills on time. Even the little ones. A cellphone bill can destroy a credit rating. If you can’t get on automatic payments, then schedule a reminder in your phone’s calendar on the date that each bill is due.
3. If you’ve had bad credit in the past, the best way to over-come it is to rebuild new credit. If a creditor has written off a debt, don’t consider the debt settled. They can leave the balance marked as unpaid and continue to update the dates, to ensure your credit won’t improve until you deal with them.
4. When dealing with creditors and collection agencies, keep records of all transactions and communications. A call log and receipt can hold up very well in Court.
5. Having a credit card or installment loan can help boost a credit score, as long as the balance is not too high. Aim to pay it off every month. Think
“gas and groceries” only in order to stay on-budget.
6. Keep balances low in relation to available credit. If the credit limit is $10,000, keeping the balance below $2,500 (or 25% of the limit) will improve the score. Balances of more than $7,500 (or 75% of the limit) will decrease the score. Going over-limit has an even more negative effect (see chart above).
7. Pay off credit card debt instead of moving it around to lower rate cards. Moving balances to other credit cards (balance transfers) and closing old accounts can hurt your score.
Good things to know:
1. Two years ago, cellphone companies started reporting to the credit agencies in Canada.
2. One year ago, mortgages started reporting to the credit agencies.
3. As of this year (currently in the process of being rolled out), mortgage repayment history will be disclosed on credit reports and will affect the score.
4. Shopping around for credit can affect your score, however, there are allowances. Equifax is currently moving to allow a 15 day window for car shopping and a 45 day window for mortgage shopping. This means that all credit checks done by potential lenders within those timeframes will be lumped together as ONE credit check, so they won’t destroy your credit rating.
5. You can tell a car dealership they are not authorized to check your credit when you give them your driver’s licence for a test drive. This will avoid accidentally allowing credit checks when you weren’t yet sure you wanted them.
6. You can get free help from Service Alberta if you are having trouble getting inaccuracies corrected on your credit report.
7. If your own bank says no, that may mean that THEY have reached their portfolio limit, not that you don’t qualify. Be open to going elsewhere.
8. Its okay to accept a credit limit increase when offered. Just don’t spend it!
9. If you don’t want to use credit, then at least use a bank account
And, last of all – but definitely not least – we can help you learn how to read your credit report and understand exactly what you can do to make your credit look good for a potential lender.