Understanding credit

Understanding credit is a critical part of putting in place the best mortgage for you. Your credit history is going to determine if you can get a mortgage and, if you can, how much of a mortgage you will receive. Understanding credit takes some education and learning.  Don’t worry though.  You don’t have to become a credit expert.  You do need to grasp the basics.  Understanding credit takes some reading, learning and application of basic tasks.  This page provides an overview of understanding credit and why its important.

What is a credit report?

Along with the credit histories of millions of other people, your credit history is recorded in files maintained by at least one of Canada’s two major credit-reporting agencies: Equifax and TransUnion. These files are called credit reports. A credit report is a “snapshot” of your credit history. It is one of the main tools lenders use to decide whether or not to give you credit.

What is a credit score?

Your credit score is a judgment about your financial health, at a specific point in time. It indicates the risk you represent for lenders, compared with other consumers.

There are many different ways to work out credit scores. The credit-reporting agencies 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.
Lenders may also have their own ways of arriving at credit scores. In addition, lenders must decide on the lowest score you can have and still borrow money from them. They can also use your score to set the interest rate you will pay.

What factors influence your credit score?

Credit-reporting agencies and lenders use a mathematical formula to figure out your credit score.

This formula takes into account various factors described in your credit report, such as:

  • your payment history (Do you carry over a balance on your credit card from month to month? Have you ever missed a payment on any of your debts?);
  • any collection or bankruptcy recorded against you (Has a collection agency had to collect an unpaid bill from you? Have you ever been bankrupt?);
  • your outstanding debts (What is the limit on your credit card? Is your spending close to your credit limit?);
  • your account history (How long have you had credit?);
  • the number of recent inquiries made about your credit report (How many times has someone asked about your credit report?);

and

  • the type of credit you are using (Do you only have credit cards, or do you have a mix of credit cards and loans?).

These factors do not all have the same weight in determining your credit score. The most important factors are your payment history, whether you have ever declared bankruptcy, and the amount of your outstanding credit balances.
Although other elements such as your mortgage information and any personal inquiries you have made may also be included in your credit report, they usually do not influence your credit score.

How long do these factors affect your credit score?

Information that affects your credit score is usually removed from your credit report after a certain period of time. The length of time that information must stay in your report depends on:

  • the province or territory where you live; and
  • the type of information.

How can you improve your credit score?

If your credit score is not as high as you think it should be, make sure that the information in your credit report is correct. If it is correct, read your report carefully to find out which factors are most likely having a negative influence on your score, and then work to improve them.

Here are some tips on how to improve your credit score:

  • Always pay your bills on time. Although the payment of your utility bills, such as phone, cable and electricity, is not recorded in your credit report, some cellphone companies may report late payments to the credit-reporting agencies, which could affect your score.
  • Try to pay your bills in full by the due date. If you aren’t able to do this, pay at least the required minimum amount shown on your monthly credit card statement.
  • Try to pay your debts as quickly as possible.
  • Don’t go over the credit limit on your credit card. Try to keep your balance well below the limit. The higher your balance, the more impact it has on your credit score.
  • Reduce the number of credit applications you make. If too many potential lenders ask about your credit in a short period of time, this may have a negative effect on your score. However, your score does not change when you ask for information about your own credit report.
  • Make sure you have a credit history. You may have a low score because you do not have a record of owing money and paying it back. You can build a credit history by using a credit card. See the next section to find out how.

How can you maintain a good credit history?

There are a number of things you can do to build and maintain a good credit history. Here are some important do’s and don’ts.

Do’s

  • Pay your bills on time.
  • Try to pay your bills in full by the due date. If you aren’t able to do this, pay at least the required minimum amount shown on your monthly credit card statement.
  • Contact your creditors if you are having trouble making payments.
  • Make sure that your monthly account statement is correct.
  • Read the statements and other material you receive from your credit card company carefully. Keep up to date on any fee increases or changes in your card’s terms and conditions.
  • Deal with companies you know and trust.
  • Get a copy of your credit report from the two credit-reporting agencies at least once a year and make sure they are accurate.

Don’ts

  • Don’t accept or use any form of credit until you understand and are comfortable with its terms and conditions, to avoid any misunderstandings between you and the credit issuer.
  • Don’t wait to report any unauthorized transactions on your account. Contact your credit issuer immediately if your bill includes items you did not buy.
  • Don’t go over the credit limit on your credit card.

Now that you’ve learned some of the basics of understanding credit you can begin to apply yourself.  Work towards a good credit history.  Follow the guidelines for creating good credit history.  Keep reading and learning.  Over time you’ll find understanding credit isn’t as difficult as most people think it is.