Many of us often wonder what exactly affects our credit score and by how much. If you’ve found yourself with a bad credit score, you may be especially concerned with how you got to this point and how to recover. Let’s take a look at how credit scores work in Canada:
There are several different models for calculating your credit score. The most widely used by banks and other lenders is the FICO scoring model, which was developed by Fair Isaac Company. While the exact formula that FICO uses is proprietary, it is no secret that it takes into account factors like your existing debt, payment history and types of credit used to come up with the score. Another popular model is the Vantage Score model which calculates the score in a slightly different way, especially in the way it views your existing debts.
Regardless of the model, all credit scoring formulas take into account the following;
- Payment history: Your payment history is one of the major factors that affect your credit score. It takes into account whether you have paid your bill on time, the duration of delinquencies and also whether there are any current delinquencies. Late payments, delinquencies, bankruptcies, civil judgments, liens and debts that have been turned over to a collection agency all affect your credit rating adversely. In the FICO system, payment history accounts for 30% of your total score. Most people don’t realize that payments made a couple of days late result in 1 month past due on your credit report.
- Existing debts: The main reason for you to have good credit is to look good in the eyes of creditors in case you need a loan. That is not likely to happen if your credit utilization, which is a ratio obtained by dividing the amount of debts by your credit limits, is high. The higher your credit utilization the lower your credit score will be. Ideally, your credit card balances should be less than 30% of your credit limit. In the FICO model, existing debts account for 30% of the score.
- Duration of credit history: Creditors like it when you have long credit history because it gives them more information about how you spend your money. At times, it may work to your advantage to leave accounts open. In the FICO system, the length of your credit history accounts for 15% of your total score.
- Inquiries for credit: You may find it unfair, but each time you file an application for a loan, it affects your credit score. Too many inquiries may give creditors the impression that you are either in financial trouble or are taking out too many loans. All inquiries made within a year are considered in the calculation of your credit score. In the FICO system, inquiries account for 10% of your total score.
- Mix of credit types: Having a good mix of different types of credit in your records is favorable for your credit score. Credit is mainly categorized into revolving accounts (credit cards) and installment accounts (mortgage, car loans and others). To have a higher score, you must have a careful balance of both types of accounts. In the FICO model, the mix of credits accounts for 10% of your total score.
The two most important things you must pay attention to if you want to build and maintain a good credit score are your payment history and existing debts. If you make all your payments on time and keep your debts low, then your score will automatically go up. To find a more complete breakdown of your score, go to the Equifax website, which is one of most widely used scoring models. You can also download our “Know Your Score” brochure to learn more about how different factors affect your score.