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In today’s financial world, your credit score is a versatile tool that can help you in various situations, such as securing loans and other credit products. In fact, your score is one of the main elements used by lenders to determine your creditworthiness, as well as the interest rate you’ll be paying for their products once you’re approved. That’s why it’s extremely important to keep your credit score in good shape whenever and however you can. It truly does make all the difference for the health of your finances, both presently and in the near future. Unfortunately, a decent income and employment history aren’t always enough to secure the credit products you want. However, those elements, coupled with a good credit score usually are.
The only problem is, your credit score fluctuates with every credit-related transaction you make, whether you’re paying your credit card bill or simply applying for a new credit product. There are a number of reasons why your credit score rises and falls. Some things, such as timely payments, make your score climb, while others, like missed payments, will ultimately cause it to drop. Then, once your score drops, it can be difficult and time-consuming to get it back up, which is another reason why you should monitor it regularly and keep it as healthy as you can.
Want to know more about your Canadian credit score? Click here.
What is a Credit Score?
Before we move on to the elements that cause your score to drop, it’s best to get a better understanding of what your credit score is in the first place, besides being a helpful financial tool, of course. Essentially, your credit score is a three-digit number that encapsulates all your actions as a credit user, somewhat like your grade point average. All your negative and positive credit transactions are calculated together to form a number that ranges between 300 and 900. If you’ve ever been approved for and used a credit product, such as a credit card or personal loan (mortgage, vehicle loan, etc.), it means that you have a credit score. It also means that a credit report has been opened in your name by Canada’s main credit bureaus, Equifax and TransUnion.
Want to know more about getting your annual credit report in Canada? Check this out.
Here, we’ll use credit cards as an example, as they’re usually the first product that puts a credit user on the map. Most people apply for their first credit card through their bank, which anyone can do once they’ve reached 18 years of age. However, some parents also buy prepaid credit cards for their underage children as gifts or for emergencies. Once you’ve been approved for the card of your choice, the credit card company reports your activity to the credit bureau they’re partnered with, who will then create a credit report for you. From that point on, every time you use your card, the card company records each action and reports it once per month. For the most part, banks and other lenders only do business with one of the two bureaus, but some will report to both. In fact, you technically have two credit scores, one with Equifax and one with TransUnion. When considering you for new credit, your lenders will look at the score from their partnering bureau.
According to TransUnion, 650 is the magic number that you should try to stay above. With a score of 650 and over, you should have little to no trouble getting approved for any credit product you need. In turn, once your score dips below 650, not only will your chances reduce, but if you are approved, you’ll end up paying a higher interest rate than someone with a better score.
Main Reasons Your Credit Score Can Drop
As we mentioned earlier, there are a number of factors that determine how your credit score fluctuates. Some of the more notable areas that can cause your credit score to drop include, but aren’t limited to:
Your Payment History
One of the main factors that affect your credit score is, of course, your history of payments towards your various credit accounts. Most credit products you use come with a minimum balance payment and a maximum payment date that you have to adhere to in order to avoid a penalty. For example, every credit card comes with a monthly statement that includes a bill. If you don’t manage to at least pay the minimum monthly payment by the due date, you’ll be charged a penalty fee, as well as interest on the unpaid portion of the bill. Paying late, making short payments or missing them completely for any credit product will have a negative impact on your credit score, especially if the bill goes for more than 30-days without being paid.
Your Credit-Related Delinquencies
In credit terminology, a “delinquency” refers to negative credit-related transactions that have become more serious than basic late penalties. When credit accounts with large balances go too long without being paid, the lender will sometimes sell them to collection agencies. If the situation becomes a matter of public record, i.e. gets brought to court, the account in collections will be reported to the credit bureau, where a notice of it stays for up to 6 years. During that time, the user’s credit score is going to drop. The same type of occurrence also happens during charge-offs, consumer proposals, bankruptcies, etc.
To find out how long information stays on your credit report, read this.
Your Credit Utilization
With every credit account you activate, comes a set credit limit. For products like credit cards, you’ll also be given the option to increase your limit after a certain period of responsible usage. However, the closer you get to your limit, the more your credit score could drop. That’s just one of the reasons why it’s important to avoid maxing out your credit cards or other accounts. According to Equifax and TransUnion, it’s best not to use more than about 30% of your available credit.
Whenever you apply for new credit, your lender will pull a copy of your credit report to determine your creditworthiness. This is known as an “inquiry”. There are two types of credit inquiries. When you yourself request a copy of your credit report, it’s known as a “soft inquiry” and will not affect your credit score. On the other hand, a “hard inquiry” is performed when a lender or other financial organization review your report during their approval procedure. Hard inquiries do cause your credit score to drop a few points. While this might not seem like much of an impact at first, too many hard inquiries will cause your score to drop drastically. A hard inquiry can remain on your Equifax report for up to 3 years and up to 6 years with TransUnion. That’s why it’s best not to apply for too many credit products within a short period of time.
For more information on credit inquiries, click here.
History/Length of Your Active Accounts
Just the same as applying for too much new credit can negatively affect your credit score, having too many accounts that are active for only short amounts of time is not the best for the health of your credit score. When it comes to credit accounts, the longer history of responsible behaviour you display, such as timely/full payments, the better your credit score will be. That’s why it’s better not to open and cancel multiple credit card accounts within a short period, especially if they have balances remaining on them. If you do need to cancel an account, make sure to pay off the remaining balance first. It’s always better to cancel a newer account rather than one you’ve had for multiple years.
The Number of Accounts You Have
Closely related to credit inquiries, having too many active credit accounts of all different kinds can be a warning to the credit bureaus that you have a debt problem and are relying too heavily on credit. On the other hand, having a variety of well balanced, responsibly used credit products can actually be good for your credit score. However, having too many random unpaid ones can certainly ruin it.
Another area that can have a profound effect on your credit score are undisputed errors made by the credit bureaus and lenders themselves. In fact, this is one of the main reasons to regularly request a copy of your credit report. With both credit bureaus’ operations based strictly online, they usually accept any information provided by lenders without examining its accuracy. Therefore, any errors may go unnoticed, affecting your credit score negatively.
To learn how to dispute an error in your credit report, read this.
Some of the common errors are:
- Incorrect personal information (name, mailing address, date of birth, etc.)
- Incorrect Social Insurance Number
- Late payments that weren’t actually late (i.e. weren’t reported on time by lender)
- Unauthorized hard credit inquiries
The more severe errors occur during cases of fraud and identity theft. Sometimes, credit accounts will be opened in your name without you even being aware of it. Using your personal information, an identity thief can open an account and apply for all the credit they want and the credit bureaus will be none the wiser. If you don’t notice and the account goes unpaid for too long, it will not only damage your credit score but could lead to more financial turbulence until the error is corrected. On top of that, the hard inquiries the lenders make into your report, thinking it was you that applied, will damage your credit score. If you have found an error in your report, you can dispute it to the credit bureau in question, and if it’s justified, they should correct it within a few weeks. If you’re worried about fraud or identity theft, you can also pay for the credit monitoring service offered for a fee by both bureaus, which should alert you whenever an account is activated in your name.
Looking to finally tackle your debt? Check out this infographic.
Improving Your Credit Score
As we said earlier, once your credit score has dropped significantly, it can take a lot of time and effort to raise it back up. That being said, one of the main ways of improving your credit score bit by bit is to be responsible and proactive when it comes to your finances and credit-related products.
Want to learn some ways of increasing your credit score quickly? Click here.
Start off by ordering a free annual copy of your credit report and checking it for any errors. While you must pay a separate fee to have your credit score included with the package, it will likely be worth it to get a better idea of where you can make improvements. Once all your information is accurate, you can begin improving your score through a record of timely, full payments, taking care of your debts one at a time. At the very least, try to lower your debt level below 30% of your available credit limit. If you find that you’re getting too near your limit, you can try increasing it to lower your debt ratio. If you don’t want to raise your credit limit, you can pay your bills more frequently, twice a month if necessary. Relying too much on credit can also be a game changer for your credit score, in that too many smaller balances, spread across multiple accounts might lead to a cycle of unpaid debts. If you find that you’re having trouble remembering to pay your debts by their deadlines, try setting up an automatic payment system through your bank. Then, for regular purchases like consumer items and household goods, pay for them using cash or debit, rather than building up a high balance on your credit cards or lines of credit.
Want to get a free copy of your credit report? Look here.
While it might be a chore, raising your credit score as much as possible not only promotes healthy financial habits, but it increases your chances of securing any future credit products you might need. What if you want a house someday? No lender will want to approve you for a mortgage if you’ve got a low score and a long history of unpaid debts. The sooner you’ve improved your credit score, the sooner you can get back to thinking about what’s really important to you.
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