Credit is a “fact of life” for a majority of North American consumers, but too many Canadians are “credit-illiterate”. Do you understand your credit report and credit score? Do you know why it matters? Here are 10 important things you need to know about your credit report and credit score in Canada.
1. Why is Credit Rating Important?
Your credit score influences any major purchase you make that requires financing. Any time you want to purchase a vehicle or a home or even a piece of furniture (or a TV or computer) on a monthly payment plan, the financier will first check your credit report.
Your credit score will determine the rate at which you will borrow money or if, in fact, you can.
The better your credit score, the lower your borrowing costs.
What if You Pay for Everything with Cash?
MYTH: Credit rating isn’t important if you don’t buy things on credit.
TRUTH: It’s rare, but some people live primarily on a “cash only” basis, making purchases only when they can pay for the item in full (even on bigger items like vehicles and houses). But consider utilities or rent.
Whenever you need to get a new service (such as electricity, natural gas, internet, or phone service), the utility company will check your credit rating before opening a new account for you. Even some landlords request a credit check before approving you as a tenant.
Even if you have no intention of carrying debt personally, what if you decide to start a business? Starting a business requires a substantial amount of money, and few can do it successfully without some form of financing.
Credit Affects Relationships
Beyond the financial aspects, your credit score can affect your relationships. Surveys show that individuals consider credit score of utmost importance in determining romantic partners. A poll from BMO listed finances as the number one reason for divorce.
2. Why Credit Matters Even When You’re Young
If you have no credit history, there’s nothing for future lenders to base a decision on. They have no unbiased answers to their questions about whether they can trust you to manage money responsibly. In today’s world with online banking, it’s the facts on a screen—not personal relationships—that make judgments on your credit-worthiness.
3. What Is Your Credit Report?
Think of your credit score like a school report card. All of your assignments and tests for the year determine your final mark. In the same way, the history of your money management determines your credit score.
A credit report gives lenders an unbiased picture of your credit history (how you’ve handled money in the past). It’s one of the main tools used to determine whether to give you credit or lend you money. It shows how good you are at managing other people’s money.
Your credit history is recorded in files (called credit reports) that are maintained by at least one of Canada’s major credit-reporting agencies: Equifax Canada and TransUnion Canada.
Your credit report is created the first time you borrow money, apply for credit, open a bank account, or sign up for a utility. Companies like banks, finance companies, credit unions, and some retailers regularly send specific factual information regarding the financial transactions they have with you to credit reporting agencies.
Anyone that does not already have a financial relationship with you must get your explicit consent to check your credit rating. Any bank that you already have an existing relationship with already has your permission to check your credit rating from time to time.
4. What is Your Credit Score?
While your credit report shows your credit history, your credit score is like a “grade” (like those on your school report card).
Your credit score is a judgment about your financial health, at a specific point in time. It shows the risk you represent for lenders, compared with other consumers.
There are many ways to work out credit scores.
Equifax and TransUnion use a scale from 300 to 900. High scores on this scale are good. The higher your score, the lower the risk for the lender.
Some lenders have their own ways of arriving at credit scores. They must decide on the lowest score you can have and still borrow money from them, and they use your score to set the interest rate you will pay.
5. What is Your Credit Rating?
Some credit-reporting agencies report the lenders’ rating of each of your credit history items on a scale of 1 to 9. A rating of “1” means you pay your bills within 30 days of the due date. A rating of “9” means that you never pay your bills at all, or that you’ve made a consumer debt repayment proposal to the lender.
A letter will also appear in front of the number: for example, I2, O2, R2. The letter stands for the type of the credit you’re using.
- “I” means you were given credit on an installment basis, such as for a car loan, where you borrow money once and repay it in fixed amounts, on a regular basis, for a specific period of time until the loan is paid off.
- “O” means you have open credit such as a line of credit, where you borrow money, as needed, up to a certain limit, and the total balance is due at the end of each period. This category may also include student loans, for which the money may not be owing until you’re out of school.
- “R” means you have “revolving” credit, where you make regular payments in varying amounts depending on the balance of your account, and can then borrow more money up to your credit limit. Credit cards are a good example of “revolving” credit.
The most common ratings are “R” ratings. The R ratings are a coding system that translates “on time”, “one month late”, “two months late”, etc., into two-digit codes. If you always pay on time, it’s coded an R1. If you never paid the amount back and it was written off, it’s coded R9.
North American Standard Account Ratings : “R” Ratings
R0: Too new to rate; approved but not used.
R1: Pays (or paid) within 30 days of payment due date or not over 1 payment past due.
R2: Pays (or paid) in over 30 days from payment due date, but not over 60 days, or not over 2 payments past due.
R3: Pays (or paid) in over 60 days from payment due date, but not over 90 days, or not over 3 payments past due.
R4: Pays (or paid) in over 90 days from payment due date, but not over 120 days, or 4 payments past due.
R5: Account is at least 120 days overdue, but is not yet rated “9.”
R6: This rating does not exist.
R7: Making regular payments through a special arrangement to settle your debts.
R8: Repossession (voluntary or involuntary return of merchandise).
R9: Bad debt; placed for collection; moved without giving a new address or bankruptcy.
NOTE: Other rating indicators you might see on a report are “I” for installment credit or “O” for open credit line.
Source: Equifax Canada
You can get a copy of your credit report. Generally, when you get it via “snail mail”, it doesn’t include your credit score. Also, it can take some time. However, you can get your credit report almost instantly online. This method requires a fee.
Consult the agencies’ websites for more information.
6. What Does Your Credit Score Mean?
When a potential lender looks at your credit report, they’re really looking for answers to a few questions:
- Do you pay your bills on time? Do you tend to pay late?
- Have you ever bounced payments?
- Have you had any bankruptcies?
- Have you mismanaged debt?
- How long have you had any existing credit?
- Have you maxed out any existing credit?
- Have you ever had credit that was closed at the creditor’s request?
Basically, your credit score shows whether you handle debt responsibly.
7. How to Build Your Credit History
Even if you have no intention of holding any debt, it’s in your best interest to work at building a healthy credit history.
It’s important to do this with intention and to start early because it takes time to build a history. It takes time to prove you’re reliable and can be trusted. You can’t just start this process and expect a high credit rating immediately—length of time matters and affects your score. So even if you’re young, it’s not too early!
Here’s how to build your credit history.
Small Credit Card
The simplest way is to build your credit history is to get a small credit card (or even a bank-managed pre-paid credit card—NOT a gift card) and pay it off every month in full before the due date. Do not carry a balance on the card. Show that you’re not overspending every month.
If you can’t pay off the whole balance, at the very least, make the minimum payment before the due date. It takes a couple of days for banks to process your payments, which is why it’s always best to pay early.
Even if you know you’ll be able to pay off the balance in full, but not until a few days after the due date, don’t wait! Make the minimum payment in time for the due date and pay the balance after the due date. You never want to miss paying minimum payment on time.
Credit cards have almost become a necessary evil. Without one, it’s difficult to rent a car, for example. So it really is to your advantage in several ways.
We often hear, “I don’t have any credit cards because I don’t believe in them.” You have a right to make that decision. However, understand that a creditor’s perspective is that people with that mindset are usually the ones who’ve had difficulty managing a credit card in the past. The assumption is that you’re not responsible with them.
It’s not a judgment on you personally. It’s a judgment based on historical experience.
Small Loan
After managing a small credit card successfully, consider taking out a smaller car loan or bank loan and pay it back—maybe even early.
Cell Phone Plans & Utility Bills
Make sure you manage your bills properly, paying them off in full and on time. The credit bureaus receive reports of your late or missed payments.
Prove Yourself
We are not advocating for carrying debt. This is simply about proving that you can manage your money wisely. Just because you have a credit card doesn’t mean you need to have debt. When you’re paying it off every month, you’re building your credit history and remaining free of debt at the same time. It’s a win-win!
8. Credit Mistakes to Avoid
Let’s look at how to prevent screwing up your credit.
Not all mistakes are created equal. Five major factors determine your credit score:
- Payment History
- Level of Debt/Credit Utilization
- Age of Credit
- Mix of Credit
- Credit Inquiries
Your payment history accounts for one-third of your total credit score.
Your level of debt, measured by your credit utilization, accounts for another third of your credit score.
The age of your credit, the mix of your credit, and credit inquiries determine the remaining third of your score.
Payment History
Because your payment history accounts for so much of your credit score, the following mistakes are the most important ones to avoid.
1. Paying a bill late or missing a payment
Late or missed payments reflect in your credit report. Some companies (including banks holding your mortgage) will typically give you one “free” late or missed payment before reporting it to a credit bureau, particularly if you’re a longstanding customer with a clean history with them. That said, don’t assume this is the case.
If circumstances prevent you from paying a bill on time, it’s best to contact the company before the due date to make alternate arrangements. If you’re being responsible and proactive in your efforts to keep your account up-to-date (despite having to pay late), most companies will give you some grace and hold off on reporting it. This is an exception to use only when absolutely necessary. Don’t turn it into a habit.
For credit card payments, remember to make at least the minimum payment on time. Don’t hold off on making a payment, even if it would mean you could make a bigger payment. Make at least the minimum payment before the due date and then make a second payment when that extra money comes in. While you may incur interest charges, you will keep your payment history intact.
2. Not paying at all
Sometimes bad things happen or we get in over our heads. If you’ve been missing payments and it’s become too much to handle, it may tempt you to give up and ignore it, hopelessly pretending it doesn’t exist. Not paying is much worse for your credit rating than paying late.
3. Having an account charged off, defaulting on a loan, or having your home foreclosed
What does it mean to have an account charged off? If your account is considered seriously delinquent (e.g. if you haven’t made your payments on time for 6 months straight), a creditor will disable your ability to use further credit on your account, but you’ll still owe the balance.
Creditors report charged-off accounts to credit bureaus. This is a serious hit to your credit rating and can stay on your report for 7 years.
Defaulting on a loan is like having an account charged off. A default shows that you have not fulfilled your end of the loan contract.
4. Having an account sent to collections
When a creditor gives up on trying to collect money from you, they’ll send your account to a third-party collector. This can significantly complicate matters for you.
5. Filing bankruptcy
Filing bankruptcy is absolutely devastating for your credit score. Do whatever you can to avoid this. See a consumer credit counsellor before opting to go this route. It’s a last-resort option. Do your research and explore all other options first.
Even though a bankruptcy is removed from your credit report 7 years after discharge, there’s still an issue. When a potential lender sees that you have no credit history (and you are old enough to be established), they’ll assume that you’ve had a bankruptcy. It takes several more years of careful credit building to change this. It’s possible, but it doesn’t happen overnight.
6. Getting a judgment
When the court must get involved to get you to pay your bills, you receive a judgment. On your credit report, this looks much worse than “simply” not paying your bills. While you want to avoid a judgment completely, a paid judgment is better than an unpaid one, so resolve it as soon as possible.
Debt Level and Credit Utilization
Credit utilization is the percentage of available credit that you’re using on your credit accounts, both individually and in total.
“For example, if your [credit card] balance is $300 and your credit limit is $1,000, then your credit utilization is 30%. To find out your credit utilization, simply divide your credit card balance by your credit limit then multiply by 100. The lower your credit utilization, the better. That shows you’re only using a small amount of the credit that’s been loaned to you.” (Source: About Money)
7. Having high or maxed-out credit card balances
Don’t assume that all will be well as long as you make the minimum payment on your credit card bills. The credit card company will be happy, but it affects your credit score negatively if your balance is staying quite high.
Having high credit card balances (relative to your credit limit) increases your credit utilization and decreases your credit score. If your credit card is maxed out, your credit utilization is 100% which is bad for your credit score, even if you’re making the minimum payments on time every month.
Using a majority of your limit and paying it off in full each month can still be detrimental to your credit score. Most credit card companies report the balance due at the close of each billing cycle. So even paying the balance in full immediately upon receiving your bill might not reduce your credit utilization on your credit report.
The best practice is to always pay your credit card before the closing date.
Just because you’re approved for a certain credit limit doesn’t mean you can afford to take on that amount of debt. Taking on too much can quickly lead to long-term debt trouble. Keep your debt to below 10% of your limit (paying it off at the end of every month). In the banking world, around 30% is acceptable. Anything over 50% looks scary to a potential lender.
8. Not paying off debt quickly enough
Credit agencies like to see that you can pay off debt in a reasonable amount of time. If you have a credit account that’s been carrying a large balance for many years, the credit agency thinks you might have a problem paying off a loan.
9. Closing credit cards
Be careful about how you close out credit cards.
Don’t cancel all of your credit cards all at once. Cancelling cards can be a balancing act. For example, if you have 2 credit cards with a $5,000 limit each and have a balance of $2,500 on one card, your credit utilization sits at 25% of available credit. However, if you cancel the card with no balance, your utilization of available credit jumps to 50%.
Age of Credit
Loyalty counts. The longer your borrowing history, the better your credit score. This is especially true if you’ve been a responsible borrower.
10. Closing (& opening) credit cards/accounts
History matters. Closing old credit cards makes your credit history seem shorter than it really is.
Credit applications should be considered carefully. Applying for a line of credit will show up on your credit report, even if you don’t open the account. If you apply for multiple accounts (line of credit or credit cards) without opening them, it can appear to potential lenders that you may have been declined, which can make them nervous.
There are people who open a bunch of credit accounts, use their credit, and then “skip town”. Naturally, lenders consider this type a very high risk!
While having credit accounts is important in order to maintain a healthy credit history and score, evaluate each opening or closing and choose carefully.
It’s good to keep older credit as long as the rate makes sense. You only need a couple of credit accounts. Don’t get sucked into every good credit opportunity.
Mix of Credit
The types of credit accounts you have contribute to about 10% of your credit score.
11. Having only credit cards or only loans
When you have only one type of credit account, your credit score could be affected, especially if there is not a lot of information in your credit history.
12. Not using credit cards
You can’t develop a credit history if you don’t have a credit account. If you don’t use a credit card, the amount of information the credit bureau can provide to determine your credit score is limited.
Your credit score tells a potential lender how good you are at managing other peoples’ money. Using a credit card wisely, even one with a small credit limit, can be a helpful tool to build your credit history, and subsequently, your credit score.
Credit Inquiries
Whenever you apply for a new credit account, your credit report is checked. Every credit inquiry is recorded on your credit report. This portion of your credit report accounts for 10% of your credit score.
13. Getting too many credit checks
“Some people get multiple credit checks in one year. You might apply for a credit card, buy a car and purchase a house all within 12 months. [This can be a problem.] Credit agencies don’t like when too many people are looking into your background. It raises red flags and questions, mainly, why are you tapping into so much credit in such a short period of time? Two credit checks in one year is fine; three could have a negative effect on your rating.” (Source: Canadian Living)
If you’re applying for credit in multiple places, it appears as though you’re struggling to stay afloat and looking for more available credit to make ends meet.
Getting credit checks for legitimate purposes is okay. But avoid the appearance of shopping around. What starts as an innocent trip to a department store can cause a quick credit card approval for the advantage of a healthy discount on your purchase. This seemingly simple transaction will affect your credit history.
Relationship Mistakes
Credit is a personal thing, but our relationships can affect our credit.
14. Assuming your spouse’s credit has nothing to do with yours
Credit bureaus keep a separate score for each individual, but the actions of your spouse can still affect your own credit score.
If you have a joint account or loan with your spouse, the activity on that account will reflect on both your credit score and that of your spouse. Even if you have a joint credit card account that only your spouse uses, the payment history of that card will show on your own credit report.
15. Co-signing a loan for a friend or family member
Becoming a co-signer is a gigantic risk to your credit score.
“The status of that loan will appear on your own credit report. If your co-signee makes a habit of paying late or carrying a high balance, that can negatively impact your score, and there’s no requirement for the bank to inform you about it.” (Source: The Fiscal Times)
Before agreeing to co-sign a loan, you must seriously consider the potential effect on your own credit score. You become legally responsible for paying off that loan if your co-signee defaults. If someone asks you to co-sign, determine if that person is a good credit risk.
One More Mistake
16. Not checking your credit reports regularly
Errors happen in the credit reporting process. Anything from a clerical error to identity mix-ups can occur, resulting in unnecessarily bad credit scores. Stay on top of your credit report by requesting a copy of it regularly. (Once a year is the general recommendation.)
9. What to Do if You Have a Bad Credit Score
Bad news: A bad credit score can affect your ability to access financing and can affect your interest rates, housing rental opportunities, and even some forms of employment. If you have a bad credit score, you need to fix it.
Good news: It’s possible to fix your bad credit score!
Here are 7 things you can do to improve your credit score:
1. Get a copy of your credit report.
Sadly, it’s possible for mistakes to be made on your credit report. Even identity theft or computer glitches can affect your credit report. You want to make sure the information on your report is accurate.
2. Correct any errors.
Once you’ve gone over your report, if you find mistakes, you’ll need to fill out forms to get them corrected.
For more information on how to do this, visit the credit agencies’ websites. You can also contact the company or institution that made the error (i.e. your bank or other lender) and ask them to make the correction.
3. Make payments on time.
Keep up to date on all of your credit card and loan payments, utility bills and rent payments. If you end up missing a payment, contact the company and ask them to remove late fees, which show up as bad marks on your credit report. This is at the company’s discretion, of course, so there’s no guarantee, but asking costs you nothing and is worth your time and effort.
4. Keep the same job and residential address as much as possible.
This consistency is seen as a sign of financial stability. Practically, staying at the same address prevents bills and notices being sent to the wrong address or getting lost in the mail.
5. Rebuild credit through borrowing.
With a bankruptcy, for example, it’s difficult to rebuild credit because it’s such a challenge to get financing or to get approved for a credit card.
It’s still possible by applying for a secured credit card with a financial institution. A secured credit card has you deposit a lump sum of money ahead of time, which is used as security against your debt. By using a secured card and paying it off in full each month, you will slowly improve your credit rating.
6. Avoid common credit mistakes.
The recommendation is that you don’t exceed a balance between 35-50% of your credit limit.
Don’t have too many credit cards and store cards. Even if they have a zero balance, lenders see them as credit risks.
That said, don’t cancel all of your credit cards all at once. Cancelling cards can be a balancing act. For example, if you have 2 credit cards with a $5,000 limit each and have a balance of $2,500 on one card, your credit utilization sits at 25% of available credit. However, if you cancel the card with no balance, your utilization of available credit jumps to 50%.
7. Limit how much & how often you apply for credit.
Every time you apply, your credit rating takes a hit. This is true even for store credit cards. Every time a retail store of any kind offers you a store credit card, no matter how small the available credit amount on the card, applying for that card will affect your credit rating.
Think carefully before accepting every credit offer that comes your way. This includes the “pre-approved” credit cards you receive unsolicited in your mailbox. Read the fine print and know that you may be giving permission for a credit check if you fill out the acceptance form.
NOTE: Anyone that does not already have a financial relationship with you must get your explicit consent to check your credit rating. Any bank that you already have an existing relationship with already has your permission to check your credit rating from time to time.
10. How to Maintain a Healthy Credit Rating/Score
Just because you have a healthy credit score today doesn’t mean you always will. You must maintain your credit rating.
Besides avoiding the common credit mistakes (above), here are 5 things you can do to maintain a healthy credit rating/score.
Educate yourself.
Take responsibility for your financial education and read books, articles, or blogs that teach you how to manage your finances effectively. Learn how to budget, how to stay organized financially, and how to make wise financial decisions.
Read the fine print.
Whenever you sign a financial agreement, read it and be sure you know and understand what you’re signing. Be aware of what it requires and be realistic about your ability to pay back any money you borrow.
Pay the minimum.
On any credit card or loan, be sure to pay your minimum monthly payment by the due date each month. Failure to do so can increase your interest rate and affect your credit rating and future financial transactions.
Pay more.
Even better than paying the minimum payment on your monthly credit card statement, pay MORE than the minimum, or even pay the balance in full each month!
Don’t rely on credit as an income source.
A well-managed credit account can be an important step toward financial responsibility and can be a smart way to establish a healthy credit rating. However, if you routinely max out a credit account or are using it for necessities regularly, chances are you are living beyond your means and setting yourself up for bad credit issues and possibly getting in over your head.
Credit Isn’t a Bad Thing
Credit isn’t a bad thing. It just needs to be properly managed, like any useful tool in our lives.
The ability to get credit is a valuable tool for individuals and businesses. We must be responsible with this tool, though, and educate ourselves, learning how to use it wisely and manage it well.
Let’s not forget the importance of educating our young people, as well. These things don’t come naturally—they must be taught.
