What is Credit Score?

A credit score can either make-or-break your chances of getting an approved loan. Having a good or bad credit score affects your ability to secure a loan. That is why improving your credit score will certainly put you at an advantage.

A credit score is a numerical value that is based on a person’s credit files that show his/her ability to pay a loan. Credit files such as a credit card, an auto loan or a home mortgage are the most commonly used files that a lender will look at.

Credit reporting agencies are the ones that usually compile and report your credit score. Specifically, there are three main agencies that evaluate and make a summary from your credit report namely: Equifax, Experian and TransUnion. They use complex algorithms or mathematical equations in order to balance each factor in your credit report.

In Canada, credit scores typically ranges from 300 to 900. Higher credit scores like 700 may give you the best deal possible with the lowest offered rates (as lows as 0.00%)! On one hand, a relatively low credit score such as 500 (or below) is likely to result in a higher interest rate. It may even affect your chance of getting approved.

These are just the basic overview about your credit score. To learn more, here are some key points that you need to know.

 

Components of a Credit Score

        Payment History. How mindful you are in paying your bills, on or before the due date, make up the single largest factor in a credit report. Although this accounts for a minority of your score, a late bill payment may stay in your credit score for up to seven years. But not all late payments are the same. Were you 30 days late or 90 days late? Did this occur last month or a year ago? These factors are all taken into consideration when calculating your credit score.

        How much you owe. A credit score reflects an individual’s current financial status. A score may change from time to time depending on the growth of your checking account or the decline of credit card debt. This component focuses on your debt-to-income ratio which compares outstanding debt to present income. This value should stay under 20% to attain the highest rating. Lenders are not only concerned at how much you currently owe but also at how close you are in maxing out your line or lines of revolving credit.

        Length of Credit History. As they say, “longer is better”. Lenders are more inclined to approve long and stable credit histories. Being new to the credit world is not a bad thing but having a long credit history makes it easier for the lenders to keep track of your credit record. Negative scores may affect your credit score but it is also balanced out with your positive scores/ rewards. This is why most financial experts recommend on keeping your oldest credit account since it takes time to build a strong credit history.

        New lines of credit. Having a new credit line is not a bad thing. But credit agencies are usually alarmed when they see closely timed, repeated “hard inquiries” on your credit report. This is because, it suggests that a borrower may have incurred too much debt or haven’t exercised restraint to take on debts which they need to pay back. In short, apply for new credit only when it is necessary.

        Types of credit. Taking on too much debt may put you at risk in having a bad credit score. But having many active accounts on different types of credit may just save you. Showing to the lenders that you have a diverse bunch of well-managed credit accounts will give them the impression that you have experience in managing credit. This also shows that you are able to pay back additional loans. A good credit mix with strong payment histories may put you at an advantage.

 

Factors that affect your credit score

        Mentioned above are some elements that influence your credit score but there are other issues that can affect you credit score. Lenders can look into more serious credit issues that can either help you secure the loan or deny you of the loan. For instance, in an auto loan, a previous repossession of a vehicle is a serious credit issue. This issue must be avoided at all cost since the lender is particularly focusing on your capability to pay a car loan.  With a successfully repaid vehicle in your credit history, you have a higher chance of getting approved than those who do not.

 

What is not part of your credit score

        Credit worthiness extends beyond just numbers. There are other important components that are not shown by your credit score. For example, your credit report does not include income or employment status nor does it show the interest rate on your credit card. To add, it does not even show other personal financial obligations like alimony.

        Furthermore by law, your credit report does not contain other information such as race, religion, national origin, gender or marital status. Building a good personal connection with a potential lender is important. Show to them that you are more than your credit score!