Are you wondering why your credit score is important, and how you might improve it?
At some point, you will most likely need to apply for credit. Then, when you apply for credit, you have to demonstrate to your lender that you can repay the loan. One of the tools that lenders use to build that trust, among other things, is your credit score.
Your credit score is usually the very first thing that a lender will check. Specifically, in North America, there are 3 primary credit reporting agencies: Experian, Equifax, and Transunion. All three credit reporting agencies are used in the United States, while in Canada, only Equifax and Transunion are used.
Lenders may choose to check one or more credit reporting agencies. To make it even more complicated, each credit reporting agency has various iterations of their own credit score. So your score may be different, depending on the credit reporting agency.
What Is The Credit Score Made Up Of?
Your credit score is a 3 digit number (Usually between 300-850) and is created by a mathematical algorithm made up of the following (According to FICO):
- 35% – Payment History and for how long. The more “on-time” payments, the better!
- 30% – Credit Utilization – It’s important that you keep LOW balances. Your credit score will be penalized if your balances exceed 25-35% of your limits. Pro tip: High limits, low balances are key!
- 15% – Credit History Duration – The longer the better!
- 10% – Types of credit used – i.e. Credit Cards, Lines of Credit, Instalment loans, Car Loans, and sometimes even mortgages.
- 10% – Credit checks – The more you apply for credit, the more you will be seen as a credit seeker, and the lower your score will be.
What does an Excellent Credit Report Look Like?
From my experience working with credit reports, those with the highest credit scores seem to have a few key factors in common:
- They keep very few accounts open (3-4 at most)
- The credit limits are high, and balances are low.
- The accounts have been open for many many years
- Payments are always reported on time, and
- These consumers rarely apply for new credit (1-2x a year, at the high end)
Why Would You Want a High Credit Score?
Easy and cheap access to financing large purchases, when you need it. For example, your mortgage will likely be the single largest purchase of your life, followed by your car, and there’s (almost) nothing worse than being declined for the funds you need to buy your dream home or car. Or worse, having to pay a much higher interest rate than someone with a higher credit score.
If getting a mortgage is important to you, it’s best to keep your credit score as high as possible – this will help get you the very best possible rates. Interest rates on a mortgage are very important as they are based on a high amount of borrowing – so even the smallest point difference can make 100’s, 1000’s and even 10’s of thousands of dollars of difference.
Obtaining a credit card with a higher credit score is also usually easy. If you are unable to apply for a credit card due to a low credit score, you might consider a secured credit card, and pay it off regularly for at least a year. Then, ask for your card to be converted to an “unsecured” version.
Tips For Improving your Credit Report (Quickly)
Look to keep very few (i.e. 3 or 4) accounts open. For example, keep a credit card for daily use which is paid off in full regularly (I.e. NEVER pay credit card interest). Have a line of credit (with a low-interest rate), and keep a low balance. So with that, CLOSE the accounts you don’t use.
If you are VERY good with your money, ask for credit limit increases. ***Careful though, if you aren’t good with money, this can be a double-edged sword.
Second, work to pay off your balances as fast as possible. Credit cards, car loans, student loans, etc. As these are paid down, your credit score should rise.
Having a mortgage and car loan won’t hurt, but regardless, be sure to make all your required payments on time. As for old credit accounts, the popular belief is to keep them. My recommendation is to keep the oldest one, and not worry about the others. I keep the old credit card account open for this purpose – I also keep it as a backup, and because I’ve had it for 20+ years.
What Do I Do if I Have a Low Credit Score?
- You’ll be paying more for interest if you are granted credit.
- It will be more difficult to obtain credit when you need it.
- Banks will generally require more documentation (employment info, tax returns, etc)
What Are The Ranges?
- 500-650: Could use some work. The lender needs some help to extend your credit. If you’re in this category, you’ll likely have difficulty obtaining new credit. Your credit file is either quite new or, you have some missed payments.
- 750-800: This is the sweet spot. The lender will believe you can pay. At 750, a lender will consider this a “litmus” test and then, subject to their own lending criteria, may review other factors (income, employment, net worth, etc).
- Anything over 800, and it’s really irrelevant. It’s true, you’re a Rock Star! Credit is generally easily obtained at this level as the lender will believe you can pay. If you are declined for new credit, it’s likely due to an extenuating circumstance (i.e. you reached an upper limit, threshold, etc).
What Happens If I Miss a Payment?
Missing a payment indicates you might be in a debt spiral. It depends on how many days were missed. For example, if you have a credit card and the statement’s minimum payment is $100, due on March 25, and you pay it on March 26, – there’s likely no issue. If you are 30, 60, 90 or 120 days late – watch out. These are really late payments and can significantly drop your score, almost overnight. Then, it can take many months, and perhaps years for your credit score to recover from such an incident. So, be sure to make (at the very least) your minimum payments on time!
Final Thoughts About Your Credit Score
It’s important to regularly check your credit report. Just like checking your bank balances frequently, it’s entirely possible that errors might come up on your credit report. Those errors should be disputed. This can also help prevent a catastrophe should your identity be stolen.