Your credit score plays a vitally important role in almost all aspects of your financial life.  Any time you are considering a significant purchase which you cannot pay for outright, and will involve debt – such as a car or house – your credit score will be closely scrutinized.  Any time you are signing an agreement or contract involving regular payments from you – such as a lease or rental agreement – your credit score will be evaluated.  

These are two of the most important reasons why it’s in your best interest to build and maintain a good credit score.  There are others as well, which we will touch on later.  So read on to learn more about how important your credit score is here in Canada, and how you can take steps to improve it.

Your Credit Score – How it’s Calculated

Credit scores are there mainly for the benefit of potential lenders – banks, financial institutions, retailers, landlords – to help them determine if you are financially worthy of entering into an agreement where you make regular payments to them. In short, they want to know you can pay before they rent you that apartment, or sell you that car, or issue you that credit card.

The major factors which go into calculating a credit score include:

• Payment history – how well you’ve paid off debt or made regular payments in the past
• How much credit you currently have – compared with how much debt you currently carry
• How long you’ve had credit – your credit history
• Any public records of your payment history
• Whether there have been inquiries into your credit standing in the past

Of these, the first two – your payment history, and your used versus available credit – represent the bulk of any credit assessment – close to 70% in most credit scoring models.  The last three factors are important too, however – a potential lender will look at public records, for example, to see if you have ever filed for bankruptcy in the past.

How a Good Credit Score can Benefit You

There are many benefits to having a strong credit score.  Among them:

Best rates on cards and loans.  The better your credit rating, the lower your rates will be when you apply for loans and credit cards.  Lenders will tend to offer you their most favourable interest rates if you can show you’re a good, reliable payer.  It can save you a lot of money over time.

Easier loan and credit card approval.  If you are in a position where you want a new credit card – from a retailer, for example – or if you’re seeking a loan from a lending institution, a strong credit score will make the process much easier.  You’ll stand a much greater chance of getting approved, faster.

Higher credit limits.  When you have a good credit score, it means you have proven your ability to pay.  This in turn means that lenders will be more willing to issue higher amounts of credit – they’ll have confidence in your ability to keep up with higher payment amounts.

The power to negotiate.  There are going to be times where you’ll be in a situation of having to negotiate a lending rate.  Lenders will be much more inclined to agree to a better interest rate, or even their very best rate, if you can show them a strong credit score.  They will be much less inclined to negotiate with you without it.  A good credit score therefore equals negotiating power when it comes to securing terms that are advantageous to you.

Easier rental approvals.  Whenever you need to sign any kind of lease – for an apartment, a house, or commercial space – the whole process will go much more smoothly if you can demonstrate a strong credit rating and payment history.  Monthly rental payments are very much like loan payments – a potential landlord is financially exposed when they take on a tenant. They want to know a tenant will make all the monthly payments they sign onto, not just the first and last month’s rent.

Cheaper insurance rates.  Insurance companies look at your credit rating too.  If you cannot show a strong credit rating when you apply for car or home insurance, chances are you will be forced to pay higher premiums to obtain that insurance.  

What You can Do to Improve Your Credit Score

There are several basic steps you can take to improve your credit score, and it’s never too late to start – although building a strong credit rating can never start too early, either.  Among the steps you can take to get a better credit score:

Develop a strong payment history.  This is the most important thing you can do to positively impact your credit score.  How well you make timely payments will weigh heavily in all models of credit assessment – a third or more of your overall rating, generally speaking, will be based on your payment history.  This means:

• Always try to make payments on time
• Make the minimum payment if you can’t make the entire amount by deadline
• Don’t hide from your lenders if you get behind – advise them of the situation
• In the case of a disputed billing, make the payment anyway, and argue about refunds later

Be careful with credit limits.  Use your credit wisely – in the case of using your available credit, less is more; in other words, don’t continually use your credit to its maximum.  A good rule of thumb is to limit your credit use to only about a third of its maximum.  For example, if your total available credit is $10,000, you should only be accessing about $3,500 of it at any given time.  That shows potential lenders you are a responsible individual, and it will significantly enhance your credit score.

Make your credit history as long as it can be.  When your credit score is being calculated, the length of time you’ve had credit goes into the mix.  The longer a history you have with it, the stronger your credit rating is – they want to see you have a track record.  This is why parents, for example, get their kids credit cards.  Used responsibly from a young age, it can contribute significantly to their credit score down the road, when it really becomes important.  

Another helpful strategy is to keep your oldest credit accounts alive, even if you’ve moved on to new sources of credit, such as a new credit card account.  Closing the old one down erases that part of your credit history; you’ll be starting from scratch with your credit score.

Don’t apply for too much credit from too many sources, especially at once.  These applications will be assessed by the agency calculating your credit score.  Too many applications for credit will indicate to them that you are potentially in need of money urgently, or that you are an individual living beyond your means.  It’s not a good signal to send, even if your applications are perfectly legitimate.  Limit the number of credit applications you submit.

Spread your credit around.  A single source of credit, such as one credit card, will impact your credit rating downward.  Rather, you should try to have several separate sources of well-kept-up credit; for example, your credit card, a line of credit at your bank, and your car loan.  A good track record with all of these will be viewed favourably as part of your credit-worthiness assessment.

How to Clobber Your Credit Score – What NOT to Do

We’ve talked about all the ways you might enhance your credit score.  To look at it another way, here is a summary of some actions which will go a long way to ruining it.  Avoid, at all cost, any of the following if you are attempting to increase your credit worthiness in the eyes of potential lenders:

Filing for bankruptcy.  In the most extreme of cases, individuals will sometimes have to resort to escaping their creditors by going bankrupt.  While life is life, and bad things happen along the way, be advised that this is a great way to completely ruin your credit score moving forward.  Filing for bankruptcy will likely be a permanent blotch on your record – a flag every time your credit score is being calculated.  It will likely result in serious impediments to you securing credit down the road.

Maxing out your credit cards.  We’ve mentioned the concept of limiting your credit use, regardless of what its maximum may be.  Topping out all the credit cards you own – from banks, to stores, and everywhere else – is a flashing red warning to those assessing your credit rating that you are not a good risk.  If you find yourself in a position where your cards are maxed, take immediate steps to rectify the situation – get them paid down as soon as possible, for the sake of your future credit rating.

Closing your oldest cards.  Remember we mentioned about a reset of your credit?  This is what can happen if you close your oldest sources of credit, such as the first credit card you ever applied for.  When you close that account, you’ve also wiped out that part of your credit history.  You’ll be starting from scratch, with only the history of your newer credit cards.  It’s not a good idea – it gives the impression you don’t have a long, successful history with credit, even when in fact you do.

Your Credit Score is Important – Guard It Carefully

You may not think about, day-to-day, a lot of what we have mentioned in the preceding paragraphs – for instance, how much credit you’re using, how many credit applications you’ve filled in lately, a missed payment or two they may all seem harmless enough.  But when it comes to how your credit score is calculated, the smallest financial mis-steps on your part all get thrown into the mix.  Added up, they could result in some unwelcome surprise when you need to apply for credit, whether it’s for a large purchase, a loan, or a new line of credit.  

If you follow all the items we have suggested you do, and stay away from the ones we’ve indicated you should avoid, you’ll be on a fairly secure path to a strong credit score, anytime you need it.  A healthy financial life is a great way to bolster your life as a whole – so like the heading says: Your credit score is important – guard it carefully.

For more expert advice on credit score, consider contacting a financial advisor today.

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