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Your credit score is one of the most important numbers in your financial life, it's used by banks and lenders to simplify the risk evaluation process for potential borrowers and help them to avoid lending money to those who are considered to be at risk of defaulting on repaying debt according to their financial history. Your credit score is basically a numerical summary of your history as a borrower.
As you might imagine, this means that your credit score will have a significant impact on multiple areas of your life, including your ability to qualify for a mortgage, personal loan, or financing for a car. It will also determine how much you can borrow, as well as the rates you are eligible for, a better credit score will secure you the lowest interest rates and best borrowing offers.
How your credit score is determined
The exact way your credit score is calculated is too complex to fully explain as it relies on a large number of fluid factors, and the exact method varies between the three major credit monitoring bureaus, but the basics are determined by the information from your credit report.
What’s on Your Credit Report?
Your credit report includes personal and identifying information such as your name (and any previously reported names such as your name before marriage), your current and previous addresses, your employment history, and your social insurance number (SIN) or social security number (SSN), as well as information about your borrowing activity, including any current or settled credit card, loan, or mortgage accounts and applications, revolving phone contracts, credit inquiries, and public records information. The financial content is what matters when determining your credit score.
What factors into your Credit Score?
Your payment history is the most important factor in determining your credit score. Weighted as 35% of your score, your payment history will include late or missed payments on accounts or borrowing, as well as any reported bankruptcies, accounts that have gone to collections, and foreclosures. Having any of these things on in your credit history will have a seriously negative impact on your score.
The amounts outstanding section of your credit report accounts for 30% of your credit score calculation and details any debt you may have, whether it comes a balance carried on a credit card, an unpaid line of credit or personal loan, the balance remaining on your car, or your mortgage. Any amount in arrears will also be listed here and flagged as such.
Owing money won't automatically have a negative impact on your credit score, what's most important is your ratio of debt to available credit, ideally you want to keep your debt at no more than 30% of your total available credit. Carrying debt above this level is what will start to hurt your credit, and it can also affect your ability to qualify for additional credit or loans as lenders may feel that you have stretched yourself too thin financially.
Length of credit history
The amount of time your credit accounts have been open, a.k.a. the length of your credit history is weighted as 15% of your credit score. This is an important consideration because it gives banks and lenders a point of reference for the information contained in your credit report, a good score says less about you as a borrower and your ability to manage money if your oldest account is only six months old than it would if you have a decade of credit history and good habits to back it up.
Borrowing and Credit types
There are multiple types of credit available, your credit cards, car loan, student loans, and mortgage all fall into different categories, and having a variety of credit types is actually beneficial to you, in fact it accounts for 10% of your credit score. The more types of credit you have, the more lenders you appeal to, which makes you a more interesting borrowing candidate than someone who only has one or two types of credit.
New credit accounts and inquiries
A counterpoint to the length of your credit history is your record of new credit accounts and recent inquiries. While having a long credit history populated with old accounts is beneficial to your credit score, opening new accounts and getting hit with the hard credit inquiries that come with applying can actually hurt it. This accounts for 10% of your overall credit score.
Because of this, if you are considering applying for a large loan such as a mortgage or a lease on a new car, it's recommended that you avoid opening new accounts for at least 12 months beforehand.
Reporting Credit Bureau
The credit bureau you choose to monitor your credit score through does not affect your score in the same way as the weighted factors listed above, but you will see some variance between them. This is because each of the three major credit bureaus (Equifiax, Experian, and TransUnion) may use slightly different versions of the FICO method to determine your score, and the information they have on you may vary as lenders are not specifically required to report to any of them.
In an effort to mitigate the confusion, companies like Credit Karma have been established and provide users with an overall score derived from the scores and information of each bureau. The Vantage Score was also developed by the three main bureaus for this purpose and was introduced as an alternative to the FICO method.
Credit Score vs Credit Range, what's the difference?
Your credit score and credit range go hand in hand. Your credit score determines what credit range you fall into so it’s important to work to get it as high as possible, but when it comes to borrowing, your credit range matters more than your actual credit score.
Making sense of your credit score
If your credit score falls between 300 to 579 you are classified as having very poor credit. Borrowers in this credit range are considered high risk and are unlikely to qualify for additional credit or loans. Should you need to borrow, you will need to have a cosigner, pay additional fees, or put down a deposit. Even with these additional securities, you will only be able to borrow small amounts and will pay the highest interest rates.
Borrowers with credit scores between 580 and 669 are considered to have poor credit and classified as “subprime”, they may be able to qualify for loans and credit cards without the extra assurances required for those in the lowest range, but they will still pay some of the highest interest rates.
Credit scores in the range of 670 to 739 are classified as good, and people that fall into this category are considered to be at low risk of defaulting on payments for the money they borrow. Once you have achieved a credit score in this range you are likely to be approved by most lenders for borrowing that is considered suitable for your income level.
If your credit score is in the range of 740 to 799, you are considered to have very good credit and will be perceived as trustworthy and reliable by lenders. You will be able to qualify for larger loans and receive some of the best interest rates at this level.
Credit scores between 800 to 850 are at the top of the range and are classified as excellent.
Lenders are eager to work with people in this credit range and they will receive the best offers and lowest interest rates available.
If your credit falls in the ranges of very good or excellent, you will receive more unsolicited borrowing and product offers, including new credit cards, credit limit increases, lines of credit, and personal loans.
Improving your credit score and repairing bad credit
You know how important your credit score is and have a solid understanding of how it's determined, but what can you do to improve it? Generally, you will need to take action to improve your standing in each of the weighted categories we mentioned earlier, which we will walk you through, but there are plenty of other things you can do that will help the process.
Pay down debts
Paying down your debts should be a top priority when working to improve your credit as it impacts a number of the factors used to determine your credit score including your payment history and utilization level.
Additionally, the longer you hold debt the more interest you accumulate on it, whether its a mortgage, car loan, or credit card balance. The more interest you rack up, the more you end up paying for the same end result, so you save money later by putting more on your debts now.
Avoid carrying balances above 30% of your total credit
Carrying a balance in excess of 30% of your total credit is one of the easiest ways to damage your credit, luckily it's also one of the easiest pitfalls to avoid, and maintaining a lower utilization will have a significant positive impact on your score.
Keep old accounts open
We already mentioned how the length of your credit history affects your credit score, but did you know that closing older accounts impacts your account history and can actually hurt your credit score?
Closing an old account or card even if its gone unused for a long period can damage your score in more ways than one, not only does it hurt the length of your credit history, removing a credit account will reduce your amount of available credit and raise your overall utilization, potentially to a level that negatively impacts your score.
Don’t apply for new credit or loans
This isn’t always something you can avoid, but if possible you should stay away from applying for new credit cards or other types of loans as doing so can have a considerable negative impact on your credit score. Additionally, frequently or consistent applying to borrow or increase your existing credit limits can make you appear as “credit-seeking” to lenders.
Being labelled as credit-seeking can actually prevent you from getting the money you need as it indicates a level of desperation to lenders which, in turn, suggests you might be at a higher risk of defaulting on your payments. The logic is that taking on debt is typically a last resort, so those who apply for multiple loans from multiple lenders are less likely to have access to the funds they will need to repay the debt they take on.
Ensure the information on your credit report is current
Thanks to the laws governing fair credit reporting, negative information that appears on your credit report must be removed after a certain period of time. For most negative information the time limit is seven years, this limit applies to charge offs, collections, delinquencies, foreclosures, paid tax liens, and student loan defaults.
Certain kinds of negative information will stay on your credit report for longer, such as bankruptcies which won't be cleared from your report for ten years. Lawsuits and judgments against you will remain on your credit report for seven years or the length of your regions statute of limitations, whichever is longer. Unpaid tax liens will remain on your record for as long as it takes you to pay them in full.
Typically this negative information will automatically be removed from your credit report when the time limit is reached, but if you notice information with an incorrect reporting date or that otherwise should have already been removed from your credit report, you will need to file a dispute to have error corrected.
Since your credit score is a reflection of your borrowing history, consistency is key to improving and maintaining a good score, this also means that improving or repairing your credit will take some time. Be patient, if you continually demonstrate good financial habits your credit score will reflect that and improve by leaps and bounds.
Maintaining Good Credit
Excellent credit isn’t something to you achieve and forget about, keeping your credit score healthy is an ongoing process that requires consistency and regular maintenance.
Stick to your habits
The steps you took to raise your credit score are the key to maintaining it once you've reached the level you desire. All of the habits you established along the way should be kept going forward in order to continue reaching your financial goals.
It may be tempting to take advantage of your hard-earned high credit score and accept large loans in order to upgrade your lifestyle with a nicer house or fancy car, but you don't want to let all of your efforts go to waste. Remember, you can ruin your credit much faster and easier than you can build it up.
Monitor your Credit
Monitoring your credit should be a part of your regular routine and is an important part of maintaining good financial health whether you have good credit or you are still working towards it. It's important to keep an eye on your credit score and make time to review the in-depth information in your credit report.
This may seem unnecessary if you are on top of your finances and borrowing habits, but it's a good habit to have and a valuable asset in protecting yourself against surprisingly common issues such as credit report mix-ups, fraud, and identity theft, which can cause serious issues for you and take months or even years to resolve.
Things to look for
There are a number of things you’ll want to watch out for on your credit report, but they can be broken down into three main categories, accounts or information that doesn’t belong to you, inconsistencies, and sudden changes to your credit score.
If you see a new account that you didn’t open, hard credit inquiries you didn’t authorize, or notice that changes were made to your personal information such as your address or contact information, you may be a victim of fraud or identity theft.
Sudden changes to your credit score may also indicate identity theft and you should be on the lookout for anything out of the ordinary which would explain the decline in your score. If you don’t have any new accounts showing up, you might notice your debt to credit ratio has increased, or that incorrect public records information was added to your account.
Inconsistencies can also be a red flag for fraud and identity theft, but they also can be attributed to simple misreporting. For example, an account may appear twice on your report in error, significantly impacting your debt to credit ratio, or if you have a common name, you may have mistakenly had someone else's information added to your account, it happens more than you might think!
If you notice anything out of the ordinary it is important you report the error as soon as possible and register a dispute with the credit agency that reported the inaccuracies to have them corrected on your account.
No matter where you start off or what condition your credit is in, you can improve and repair your score. Putting your new financial knowledge to work in combination with a bit of effort, consistency, and time will get you into the credit range you need to achieve your financial goals.
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