If you’ve ever had trouble getting approved for a loan or a new credit card then you might feel like you’re being targeted or like the system is set up to prevent you from getting the money you need when you need it. Given that your credit scores are reflective of how you’ve used credit in the past, it’s easy to see why some people believe that the credit score system is set up in a way to tie consumers to their debts and bad financial decisions for as long as possible.
In fact, some people believe credit scores are a scam, but is it true?
In order to understand whether credit scores are a scam or a legitimate system that is useful, you’ll need to know what are credit scores and how it works.
A credit score is a 3-digit number that can range anywhere from 300 to 900. Good to excellent credit scores fall between 600 to 900 while bad credit scores fall between 300 to 559. Everything in between is considered fair credit.
Credit scores can impact your ability to not only access different credit products but also rent an apartment, or get a job. Lenders and other third parties will use it to determine the likelihood that you’ll pay your bills or debts on time.
Your credit scores are calculated based on the information in your credit report. When lenders pull your report, the score they get will differ from what you see as the credit bureaus have developed multiple credit scoring models that they sell to the lenders. Depending on the credit scoring model used the credit score they see may differ from the one you see.
However, in general, there are five common factors used by most credit scoring models. The main difference is the weight attributed to each factor. For example, one credit scoring model may put more weight on the number of credit inquiries over your credit account age.
Credit scores are not a scam, however, their efficacy is debated by some. The intended purpose of credit scores, as previously stated, is to help lenders assess a borrower’s risk. However, there are a few things about credit scores that may make it confusing and inconsistent:
In Canada, you can have multiple credit scores, all of which may vary. In fact, there is no limit on how many credit scores you can have and they can vary due to a number of factors including:
While good credit usage will eventually lead to good credit, there’s no particular action that will guarantee an increase in your credit scores. For example, paying your bills on time may help your credit scores, but the exact impact it has will vary by each individual. For some, they may see an immediate increase, while others may see no change.
Credit scores are a classic example of a Catch-22. In order to get good credit, you need to use credit, but in order to access credit, you need good credit. This paradox makes it incredibly frustrating for individuals as they may have the income and financial resources to comfortably afford a loan. Yet, they may be rejected or get stuck with high-interest rates and poor terms due to their credit scores.
Credit scores are important because they help lenders determine whether or not you get approved and for how much. Lenders also use credit scores for the following reasons:
Credit scores are an effective and efficient way for lenders to make a quick but informed decision about a potential borrower. When lenders are able to make quick decisions they are in return able to make a lot of them which allows more borrowers to get their loans or credit faster.
Lenders use credit scores to evaluate a borrower’s creditworthiness. The higher the borrower’s credit score, the lower the likelihood they’ll default on the loan. As such, lenders will use credit scores to make quick decisions that’ll earn them a profit when evaluating a borrower’s application.
Just remember that lenders want to lend money, it’s how they maintain their business. Alienating borrowers to the point of not wanting to borrow anymore is not the end game of a lender.
While it might seem like all lenders are out to reject you, when it comes to getting a loan the ball is in your court. Your credit is a reflection of how you’ve used credit. To avoid being rejected due to poor credit, you can work on building good credit by:
If you’re an adult, have a job, or a family then a good credit score is essential, especially if you need financing to buy a home or car. If you responsibly use credit by paying your bills on time and keeping your credit utilization low, you’ll be able to build or maintain good credit. Credit scores can be confusing, so do some research and find out what credit scores are all about.
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Priyanka Correia is a Marketing Coordinator and personal finance expert at Loans Canada. Priyanka completed her Bachelor's degree in Marketing at Concordia University and has published work that has been mentioned in various news media. She is passionate about money management and educating Canadian consumers about how to take control of their financial lives.
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