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There is nothing I love more than learning along with you, my readers. Recently, I have had many people ask me to teach them about credit scores. While I knew what a credit score was, I couldn’t explain where the number came from. So I jumped at the chance to learn something new and share it. I hope you learn something new, as well!
Credit Scores 101
You have probably heard the words ‘credit score’. You probably know that you have one. But do you know what a credit score is and why it should matter to you?
What is a credit score?
Your credit score is essentially your financial grade. This grade is a number that indicates how likely you are to repay any debts. Creditors will use this number to decide how risky it will be to provide you with a loan. The higher your score, the more likely you will be able to pay back your debts. The lower the score, the riskier it may be to lend you money. This means that the higher your credit score is you are more likely to receive a lower interest rate. The opposite is also true. If your credit score is on the lower end, if you end up getting approved, you may be stuck with a higher interest rate.
How is it calculated?
Your credit score ranges between 300 and 900 points and is based on information contained in your credit report. Credit reporting agencies in Canada collect financial information on you. This information includes how often you pay your bills, if you pay your bills, when you pay your bills, and how long it takes you to pay your bills.
Your credit score is comprised of 5 key categories: payment history, utilization, credit history, credit inquiries, and public records.
Payment History (35%)
Lenders look at your payment history first because your past behaviour is a very good indicator of your future behaviour. Have you missed payments in the past? You’re more likely to miss payments in the future. Always make sure to make all payments and pay them on time.
Related: The #1 Rule for Credit Cards
Debt utilization is how much of your credit you are actually using. For example, if you have a $10,000 credit limit on your credit card but on average your balance is around $1,000 then you are only using 10% of your available credit. This shows lenders that you are financially responsible and less likely to overleverage yourself.
Length of Credit History (15%)
Your loans, credit cards, rent payments, utility payments, and mortgages are part of your credit history. The longer you have held these types of credit, the more information lenders have on your financial history. A longer credit history allows lenders to see a larger picture of your financial past and helps them to determine what your credit risk is.
Credit Inquiries (10%)
Each time you apply for a new form of credit (credit cards, loans, etc.) a credit inquiry is run by the lender. These inquiries can hurt your score if you apply for a lot of new credit in a short amount of time. A high number of inquiries can show that you are spending beyond your means, which is a huge red flag for lenders. If you are spending beyond your means you are less likely to be able to repay your debts.
Public Records (10%)
Have you filed for bankrupcy? Or forgot to pay your taxes? Both of these are examples of public records that could appear in your credit report.
What’s your number?
No, not THAT number! What’s your credit score?
Don’t know your number? Borrowell will check your credit score for free! They will also send you an email every few months reminding you to check your credit score.
Now that you know your number, what does it mean? As mentioned above, credit scores range from 300 to 900 points. While it varies from lender to lender, a good credit score is anything above 650. Any lower than 650 and you may run into issues obtaining financing.
- 750-900 – Excellent: a safe credit risk
- 650-749 – Good: Fairly safe credit risk
- 575-649 – Fair: Above average risk profile
- 500-574 – Poor: High-risk customer
- 300-499 – Bad: Extremely high-risk customer
You may not be happy with your credit score as it stands today. Don’t panic! There are ways to improve your credit score (stay tuned for a post detailing how)!
Remember that information does not remain on your credit score indefinitely. Typically, information will only remain on your credit report for 6-7 years. This means, that even if you made financial mistakes in the past, you will have them erased from your report in 6-7 years!
Why should you care?
Your credit score can affect your financial plans in the future. If you are applying for a mortgage your bank will run your credit report before approving you. If you are approved, the interest rates may be tied directly to how high or low your credit score is. Applying for a credit card? You’ll want a decent credit score! The better your credit score is, the better you are set up for your financial future.
Be sure to continually monitor your credit score. Personally, I use Borrowell!
Interested in a really detailed post all about your credit score? Check out Nick’s post at Mapped Out Money!