How a Better Credit Score Can Help You in 2018By Bryan in Credit
2018 is right around the corner and it’s time to start looking toward your future. Not just the near future, but the decades to come as well. While living in the now is a good principle to abide by, it never hurts to consider where you might be as the world progresses. That means thinking about what vacations you’d one day like to take, whether or not you’ll get married and start a family, put your existing children through university or buy a house. While your mind might be full to the brim with any number of life goals, one thing is for sure, building a healthy financial future is one of the best ways of achieving them.
As we’ve mentioned in many of our previous articles, one of the most effective ways of gaining that oh-so-desirable future is by improving and maintaining a healthy credit score. What does your credit score have to do with your life goals, you might ask? Well, we’re here to answer just that. At Loans Canada, credit and credit scores are our bread and butter. We know, there are ways that your credit score can be low and you can still get approved for various credit products. Then again, there are plenty of reasons why you’ll be better off trying to raise your score or use your already high score to your advantage.
What Qualifies as a Good Credit Score?
Your credit score is a 3-digit number, ranging from 300-900. It functions like a collective average, summing up all your transactions as a credit user. If you make good transactions, like timely and full bill payments for any of your credit products (credit cards, lines of credit, personal loans, etc.) your credit score goes up. In turn, if you make irresponsible transactions, like late, short, or missed payments, then your score drops. The closer your score is to 900, the more creditworthy your current and future lenders will consider you. On the other hand, the closer it is to 300, the more of a borrowing risk your lenders may deem you, thinking you have a debt problem.
According to TransUnion, one of Canada’s two main credit reporting agencies (Equifax is the other) a credit score of 650 or more is the ideal point where lenders, such as banks and other traditional financial institutions, will consider you a low borrowing risk. And, of course, being a low-risk borrower can open up all sorts of financial avenues for you. Once you’ve reached 750, your credit is considered excellent and you’ll have little to no problem getting approved for any credit products on the market.
Want to know why your credit score dropped? Read this.
If your credit score is 640, don’t worry too much, it doesn’t mean you’ll automatically be rejected when you apply. There are plenty of other factors that lenders will take into account before they deny you credit, such as your income and employment history. For example, you might have a lower credit score, but an income that’s good enough for your lenders to feel confident that you’ll keep up with your regular payments, interest and all. However, there are certain things you might miss out on, like more favorable interest rates, a subject that we’ll discuss in just a few moments. So, it’s always in your best interest to take care of your credit rating and credit score, because you may require their help as 2018 gets underway.
Click here to discover the difference between a credit rating and a credit score.
Factors that Affect Your Credit Score
As we said, there are various types of credit-related transactions that affect the way your credit score fluctuates, such as on-time/full bill payments versus late/short ones. However, those kinds of transactions are only part of a much broader picture. Strictly speaking, there are 5 main factors that affect how your credit score looks.
Your Payment History = 35%
You guessed it. The biggest, most important factor for your credit score is the way you’ve been paying or not paying for your credit products. No credit products are free, whether they be mortgages, car loans, short-term loans, or even credit cards that are labeled as “no annual cost”. Someday, if you use the product you’ve been approved for, you’ll need to make a regular payment, including interest, to return the favour to your lender.
Using credit cards as an example here, paying your monthly credit card bill balances, in full and on time, will cause your score to rise. Even if you only manage to make the minimum payment by the due date, it’s still better for your credit score than skipping the payment altogether or paying it late.
Just make sure not to get caught in the minimum payment trap.
Generally speaking, most credit card companies give their consumers a 30-day grace period to pay their bills before they report such delinquent activity to their respective credit bureaus. So, if you manage to make a payment before that 30-day mark, you’re in luck. While you’ll be charged a penalty fee and a percentage in interest in accordance with how much you owe, your credit score may not be damaged. However, anywhere after that point will definitely lead to your score dropping. In turn, a history of this type of behaviour is a surefire way to ruin your credit score. A string of untimely payments is also a telltale sign to lenders that you might not be a creditworthy individual and that you would be at risk of defaulting when you apply for new products later on. Additionally, while a late payment or two might be acceptable when it comes to your credit cards, it definitely won’t be for high-stakes products, like your mortgage or car loan.
Want to know what else happens when you stop paying your credit card bill? Read this.
Your Credit Utilization Ratio = 30%
The second most influential factor when it comes to how your credit score fluctuates is what’s known as your “utilization ratio”. In other words, the amount of credit you use from month to month weighed against the credit limit that your lender has granted you. When you’re approved for various products, such as credit cards and lines of credit, you’ll be approved for a certain amount of available credit. Afterward, the closer you are to that limit, the more your credit score will be affected when you don’t manage to pay off that full bill payment before each designated payment date. For example, if your credit limit is $10,000 and you’ve used up $9,000 of it, the longer you go without paying your full balance, the more your credit score will drop. However, if you do pay off the full balance every month, your credit score will rise gradually.
What’s the difference between revolving credit and a loan? Find out here.
As it stands, many financial experts recommend that you not use more than about 50% of your available credit between payment dates. In fact, staying under 30% is preferred. If you find that you’re having a hard time remaining below that level, you can request a credit increase. If you’ve had a good track record of debt management for a certain period of time, for products like credit cards, your lender might even send you a notice that you’ve been preapproved for an optional credit limit increase.
Your Credit History = 15%
Going hand-in-hand with your payment record, your credit history doesn’t just make up a significant portion of your credit score, it’s also important for the health of your credit report. The longer you’ve been managing an active credit account responsibly, no matter what the type of product it’s for, the better it will be for your credit score. For instance, one or two credit cards that have been active and paid on time for several years are far better for your score than numerous cards that have been activated and cancelled within a short period of time. However, if you ever need to cancel a credit card, it’s best to cancel the one with the shortest history, even if it drops your score a bit because the older accounts are the more favorable ones.
Your Credit Product Variety – 10%
Building a good credit history takes time and so does maintaining a solid credit score. Another thing that can help with both of those elements is having a variety of well-managed credit products under your belt. In other words, if one credit card or loan that is paid on time is good for your score, a number of similar products are even better, as long as you’re being responsible with all of them, that is. In fact, most lenders like to see a history of well-managed products when they’re considering you for new credit, as it shows them that you are a creditworthy individual who isn’t likely to default.
Credit Inquiries – 10%
Last, but certainly not least, the inquiries made by your present and potential lenders towards your credit report also affect your credit score in various ways. When you apply for a new credit product, your lender, whether you’ve been with them for years or you’re applying for the first time, will check your credit report to determine your creditworthiness. This is known as a “pull” or “inquiry”, of which there are two types. A “soft inquiry” occurs when you check your own report for whatever reason and won’t affect your credit score at all. “Hard inquiries”, on the other hand, do cause your credit score to drop a few points. While one or two hard inquiries won’t damage your score greatly, a large number of them will, especially if they’re all being done within a few weeks.
For that reason, it’s best to not to apply for multiple credit products, all at once. Not only will doing so cause your credit score to drop, but it’s a sign to any potential lenders that you’re frequently applying and being denied for new credit. This, in turn, might make them question whether or not you have a significant debt problem. If other lenders aren’t approving your applications, why should they?
Check out this infographic to learn how bad credit can affect your daily life.
What a Good Credit Score Can Do For You
Now that we’ve learned about how your credit score functions, it’s time to look at the ways a good score can benefit you as the new year rolls on.
Better Chances of Approval
Besides the fact that a high credit score is good for your finances in general, lenders will be more likely to approve your applications. When a potential borrower has a low score, it could be because they have a problem managing their debts. If your own score is low, even if the cause of it was a one-time issue for you, it’s a warning to your lenders that the same issue could occur somewhere in the near future. As a result, your applications could be denied. On the contrary, when you have a high score, the lenders take it as a sign that you’re a responsible person financially and that you aren’t as likely to miss or make late payments. So, the higher your credit score is, the more creditworthy you’ll be judged as.
Lower Interest Rates
The interest rate you receive for any credit product is a huge factor when it comes to the money you’ll end up paying in the years that follow, particularly when it comes to high-cost products, such as mortgages and car loans. “Interest” refers to a certain percentage that all lenders must charge for their products in order to make a profit, on top of the regular payments you’re already making, that is. The lower your credit score is, the higher your interest rate will be. The higher your interest rate is, the more you’ll have to pay over time. Therefore, a good credit score could help you save a lot of money down the line, because the better your score is, the more favorable interest rate you’ll be approved for.
To learn how to deal with rising interest rates in Canada, click here.
Higher Credit Limits and Larger Loan Amounts
While a higher credit score can help you gain approval for various credit products, it can also get you access to more credit than a borrower with a lower score. When you apply for any credit product, your lender uses your creditworthiness, part of which is your credit score, to calculate a certain amount of money that they’re willing to grant you. The better your score is, the more available credit you’ll be approved for. If you have a credit card and a good score, you’ll be offered a higher credit limit. If you’re applying for a mortgage or any other type of loan, you’ll be approved for a larger amount of money.
Improving Your Credit Score and Your Financial Future With It
All this being said, it’s clear that the higher your credit score is, the better off you’ll be when it comes to your future finances. In fact, maintaining good credit goes hand-in-hand with saving money. That means that, with a good score, you’ll not only be able to someday afford the things you really need, whenever you need, but it’s also one of the first steps you can take toward your eventual retirement. True, many people don’t mind working into their later years, early retirement isn’t for everyone. However, it’s always nice to have the option, isn’t it?
Therefore, it will be beneficial to financial health to improve your credit score whenever you can. Here are some of the ways you can do just that:
- Making your bill payments in full and on time – Nothing labels you as an irresponsible borrower more than making late or short payments or missing them entirely. If you can’t afford to make your full payments, inform your lenders immediately to work out a more flexible payment schedule. For credit cards, sticking to the minimum payment may not be the best idea, but it will save you from racking up late penalties and damaging your score too badly.
- Lower your credit utilization ratio – For the best results, it’s recommended that you try to stay under 30% of your available credit.
- Build and maintain a solid credit history – While it takes a lot of time and effort, a good history of well-managed credit products is better than having a history of poorly managed ones or none at all. What’s the difference between a bad history or no history? Read this.
- Limit your credit applications – As we mentioned, too many hard credit inquiries can definitely damage your credit score. So, make sure to wait a few weeks, even months, between each application.
For a more detailed look at improving your credit for 2018, check out this article.
As we said, your credit score isn’t the only thing that lenders will examine before they decide to approve you for credit products. However, it’s definitely one of the most important factors when it comes to determining your creditworthiness. If your credit score is low, don’t wait. Be proactive and take the necessary steps to improve it now, because it will certainly benefit you in the future.