What is a credit score, and why should you care?
Understanding how credit scores work and why improving your credit score is important. Do you want to learn about credit scores and how they impact your life? If you’re reading this article, we’re going to assume you have at least some interest in improving your overall knowledge of this often misunderstood subject. We’ll teach you everything you need to know and get you on the road to being a credit score expert in no time.
A tale of two credit scores
It’s been proven through research and testing that providing real-life examples is one of the most helpful ways to teach new concepts. So for this subject, we’re going to give you a couple that should make the learning process easier and hopefully, a little more fun. Our article will set out two scenarios with imaginary people that will encounter very real situations.
Please note: If you don’t wish to read two enthralling tales of people with very different financial habits and want to get straight to the nitty gritty of credit scores, then please feel free to scroll down to: What is a credit score exactly?
Sam Spender: credit score 515
Sam Spender is a recent university graduate who just entered the workforce with a salaried job at a well-known corporation. When he’s not captivated by a game of Call of Duty, you can find him hanging with his mates at the local pub. He’s an example of what can happen when you don’t stay on top of your credit.
Sam makes $80,000 per year as a software developer (yes, that’s entry level, and yes, it’s okay to be reconsidering your career choice now) and has a carefree approach to his finances. He rents a spacious and modern apartment in a desirable neighborhood downtown and likes to dine at some of the trendiest restaurants several times a week.
He has two credit cards, and they’re almost always at their limits. While he does make the minimum payment each month, he almost immediately spends to the maximum again (Sam also has a pretty sick sneaker collection).
Sam’s maxed-out cards mean that he has a high credit utilization, which is the amount of credit he’s using, vs. his credit limit. While Sam is blissfully browsing for his next sneaker purchase, his credit score is being negatively impacted. This is because banks and credit bureaus view high credit utilization as a sign that you can’t manage credit responsibly.
A few months back, one of Sam’s best friends asked if he would co-sign for a vehicle loan he couldn’t qualify for by himself. Being the swell fellow that he is, Sam didn’t hesitate to help out. As it turned out, his friend ended up losing his job just a few weeks later and couldn’t make payments. He’s working again, but is still behind on the loan. Each car payment missed negatively impacted Sam’s credit score. Had his friend continued to be unable to make payments, Sam would have had to step in to make the payments, or default on the loan (further damaging his credit).
Would you be surprised if we told you that Sam has never checked his credit score? Probably not. All Canadians can check their credit score for free, which can help them notice downward trends, prevent identity fraud, and more. If Sam had taken a look, he might have been able to reduce the damage to his credit score and worked on building it.
We know what you might be thinking: Sam needs to get his act together! The truth is that this type of behaviour is very common, and even more so for those who don’t have the life experience or access to guidance that helps with these types of situations.
Alright, back to the story. Sam recently decided that he wanted to finance a new vehicle. He walked into the car dealership with confidence and picked out an SUV with all the bells and whistles. The manager happily took him to the finance department where they asked him some basic questions about income and expenses. That’s when they pulled his credit reportTime froze. Sam’s ears were ringing. He couldn’t believe what he was hearing. Not only would he be unable to get the vehicle he wanted (the finance person suggested something from the used lot), but that the interest rate on his loan was going to be very high, making his monthly payments more than he could afford—no car for our dear friend Sam.
There are many lessons to be learned from this story. If you don’t want to make the mistakes that Sam has made, then you can read our article about common credit mistakes and how to avoid them.
Keep reading for a wonderful tale with (spoiler alert) a more positive ending that will provide some helpful pointers on what you should do if you want to have credit score success.
Diligent Danny: credit score 780
Diligent Danny is a married mother of three young boys who loves to take her two dachshunds to the dog park on weekends. She’s a part-time restaurant server that makes about $2,000 per month, including tips. Her husband works as a bus driver for the city making $40,000 per year. So, their gross household income is roughly $65,000 per year.
This makes things pretty tight budget-wise, considering the cost of extracurriculars for her sons, like swimming lessons. Not to mention, keeping everyone fed with the price of groceries these days is hard. As for housing, their family rents a small townhouse in a nice community, so they don’t have a mortgage.
Every cent counts, and Danny makes sure that each dollar is tracked. No purchase is made without careful consideration.
The family has a cashback credit card that they use for making everyday purchases like gas and groceries (her card gives her bonus cashback in these categories). This card typically isn't maxed-out, but it often has around 30% of the limit being utilized at any given time. Danny makes sure to pay it down regularly and checks that her credit utilization isn’t too high.
It’s also important to point out that Danny always makes her payments on time. She’s never late making the minimum payment on the due date each month. Furthermore, she’ll sometimes pay more than the minimum in order to give herself some room on her card and to have positive credit reporting.
About five years ago, Danny and her husband financed an affordable used vehicle through their bank at a relatively low interest rate. This modest purchase was still a big commitment, but nothing they couldn’t afford, and certainly not an undue hardship on their family.
Today, they have almost completely finished paying off the vehicle and have resisted the urge to upgrade or trade it in for something newer or more luxurious. This older account actually looks quite good on their credit report, as it demonstrates consistency and stability to lenders.
Last week, Danny and her husband made a monumental step in their family’s story. They decided to apply for a mortgage and purchase a home. They had been saving up for a down payment since they got married. They were a little hesitant at first, knowing that they brought in a modest income, but within a few short days, they were approved for their first home!
Their mortgage advisor informed them that their excellent credit score had been absolutely essential in getting them a fast and easy approval. Danny’s diligent financial habits and discipline empowered her to make their dreams come true.
If you want to learn how to succeed financially like Danny, then you may want to read our article that will teach you 5 simple ways to build your credit score.
What is a credit score exactly?
A credit score is a number that represents your creditworthiness. It’s used by lenders to determine if you’re a good candidate for a loan and what interest rate you’ll be offered. Your credit score is based on your credit history, which is a record of your borrowing and repayment activity.
The information in your credit history is used to calculate your credit score. It's important to keep in mind that there's no one magic number that will guarantee you'll get approved for a loan or get the best interest rate. Lenders will look at your whole financial picture, not just your credit score, when making their decision.
Why does your credit score matter?
Your credit score is one of the most important factors that lenders consider when you apply for a loan or credit card.
A good credit score can mean the difference between getting approved for a loan and being denied.
A bad credit score can also lead to higher interest rates on loans and credit cards, which can cost you hundreds or even thousands of dollars over the life of the loan. Monitoring your credit score is also important so you can make sure you're always in good standing with lenders, and because it can help you identify potential problems early on.
If you see a sudden drop in your score, it could be an indication that something is wrong—perhaps you’ve been making late payments or maxing out your credit cards. By catching these problems early, you can take steps to fix them before they do serious damage to your financial health. That’s why it’s so critical to understand your credit score and what factors influence it.
The primary factors used in calculating your credit score
While we decide how much we need to care about credit scores, it’s important to get an idea about how they work. How is a credit score calculated in the first place? Let’s break it down!
The main purpose of a credit score is to predict the likelihood that a person will repay their used credit. Pretty straightforward, right? But what factors are included when an organization wants to measure your creditworthiness?
- Your payment history
- Your used credit vs. your available credit
- Your credit history length
- Your credit file inquiries
- Your public records (bankruptcies, liens, etc.)
- While these are important factors, this isn’t an exhaustive list. It’s paramount to understand that some lenders will look at additional factors prior to providing you with credit. For example, a mortgage company will want to know your income as well as other personal information.
- What the lender really wants to know is that when they provide you with a loan, you’re going to pay it back. So they could ask for almost anything that will assist them in making an accurate prediction about that. Here’s a general breakdown of the factors that we mentioned above:
- Your payment history. There are quite a few elements that make up this piece of the puzzle. Your payment history will include how you’ve handled credit cards, lines of credit, auto loans, student loans, home equity loans, mortgage loans, and other credit. This category will have details on late or missed payments, as well as information from collections.
- How much of an impact these elements have will depend on how late the payment was, how often you missed the payment, and how many of your accounts are delinquent vs. the number of accounts on your file.
- Your credit used vs. your available credit. This is also referred to as your credit utilization. This important factor in your credit score measures how much of your total available credit is being used at any given time. It includes how much is being used on your credit cards, as well as any other revolving lines of credit. A revolving line of credit is a loan that lets you borrow, repay, then reuse a line of credit up to its available limit. Also factored in is your total credit limit or the total amount you can borrow against a specific credit account (say $5,000 on your Mastercard®).
- Your credit history. Your credit file shows how long your credit accounts have been around. The credit score calculation will typically show how long your oldest credit account has been open, as well as your newest. Creditors want to be able to get a clear picture of how you have handled credit over a long period of time.
- Your credit file inquiries. No matter what the reason is for your credit file being accessed, the request for information is logged as an inquiry. You have to give your consent for this to happen, and it could impact your credit score. The inquiries that could have an affect on your credit are the ones where you are actively seeking credit. If you’re shopping around for credit too much in a given period of time, it could be interpreted by creditors that you’re experiencing financial distress.
- Your public records. Public records can remain on your account for anywhere from three to seven years, and they include bankruptcies, legal judgements, liens, and really anything that could make creditors think that you’re a risky person to provide credit to. Additionally, the presence of any of the above-mentioned events could have a negative impact on your credit score.
What is a credit report?
Next, you’ll need to know what a credit report is so you can better understand what a credit score is (and why you should give a darn in the first place).
In short, your credit report is a detailed summary of your entire credit history. Lenders send information about loans you have taken out to the credit bureaus (also known as credit reporting agencies). Your credit report is created when you take out credit for the very first time.
- Credit fact: There are two main credit bureaus in Canada, Equifax and TransUnion. Both of them are private companies that store, collect, and share information about your financial experiences with creditors in Canada.
How do you read a credit score?
A credit score in Canada is a number between 300 and 900 that shows how likely you are to repay your debts. The higher your score, the better. A score of 700 or above is considered good, while a score of 800 or above is considered excellent. Generally speaking, a poor credit score is anything below 650.
However, the exact score you need will depend on the lender and the type of credit you're applying for.
As we mentioned earlier, there are two main credit bureaus in Canada: Equifax and TransUnion. Equifax scores range from 300 to 900, while TransUnion scores range from 300 to 850. Creditors report to the credit bureaus on a regular basis, usually monthly.
The information they provide is used to calculate your credit score.
There are a few things you can do to improve your credit score such as paying all of your bills on time, keeping your balances low, and only applying for new lines of credit when you need them. You can also check your credit report for errors and dispute any inaccuracies that you find.
We want to remind you that there is no one “perfect” credit score. Lenders look at your entire financial picture—not just your credit score—when considering you for a loan or credit card. They also take into account your income, debts, and other factors.
Disputing errors in your credit report
When you review your credit report, you may find errors that could be hurting your credit score. If you find errors on your credit report, you can challenge them with the credit bureau by filing a dispute online or by mail. Be sure to include any supporting documentation that you have to back up your claim.
The bureau will investigate and make any necessary corrections to your credit report.
If they find that the information on your credit report is accurate, they won’t make any changes. It's important to keep in mind that disputing an error on your credit report will not remove it from your report if the information is found to be accurate. However, if you have evidence that the information is inaccurate, disputing it could help improve your credit score.
What is the average credit score in Canada by age?
According to data from millions of users in a 2022 study, the average Canadian credit score for all ages is right around 670. If you have a credit score over this average, it’ll make it easier for you to qualify for credit products, so consider it as a marker for your credit score goals.
Equifax Canada reports that with the exception of Generation Z (cue the applause), the average credit score among Canadians has slowly gotten lower over the past ten years. The average credit score for the youngest age group of Canadians is 692, while the average credit score for those 65 and older is about 750.
Keep in mind that credit score providers like large nationwide credit bureaus—Equifax and TransUnion—use different types of credit scoring models and potentially different information to calculate credit scores.
See how you can view your credit score with Neo.
How do I get a free consumer disclosure?
A consumer disclosure is a thorough report containing all of the information on your credit report, as mandated by consumer reporting legislation.
You can get your consumer disclosure for free online from the Canadian Government. There are some other companies that may offer to provide your credit report for free. The best bet is to visit the Government of Canada’s website to view your free consumer disclosure.
