How the Money You Owe Affects Your Credit Score
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If you’ve never needed to apply for a loan or rent an apartment, it’s possible that you don’t know much about your credit score. It’s a handy piece of information to have though. You should know what your score is and, more importantly, you should understand the information used to calculate it.
What is Your Credit Score?
In Canada, there are two main Consumer Reporting Agencies (CRAs), Equifax and TransUnion, that collect information about your credit utilization. If you have ever obtained a mortgage, taken out a loan, used a credit card, or even opened a cell phone account, your information has been reported to the credit bureaus and you have a credit report. The information in your report is used to calculate a score, usually between 300-900. The closer you are to 900, the better your score. Generally, you will fall into one of several categories:
- Terrible (less than 500)
- Very Poor (500-579)
- Poor (580-619)
- Fair (620-679)
- Good (680-719)
- Very Good (720-779)
- Excellent (780+)
At the lowest level, you probably have a bankruptcy or consumer proposal in your credit file and your chances of being approved for a loan are, unfortunately, not that great. If you have an excellent score, you likely pay your bills on time, every time and lenders will be more likely to approve your credit application.
How is Your Credit Score Calculated?
There are five main factors that the CRAs use to calculate your score, each of which carries a certain weight in the calculation:
- Payment History (35%)
- Amount of Debt You Carry (30%)
- Length of Credit History (15%)
- New Credit Inquiries (10%)
- Types of Credit Accounts (10%)
Keep in mind that your creditors may report to one agency or the other, so your credit score may vary between the two bureaus. Additionally, lenders may assign weight to certain factors differently than the CRAs, based on their own priorities.
You can check your credit file, for free, every year by ordering a report from Equifax or TransUnion. We always recommend that everyone do this as there may be errors in your personal information or within your credit accounts. You’ll want to have a look to make sure your payments are being reported accurately and to make sure there are no errors that could indicate identity theft.
Unfortunately, the free reports do not include your credit score, but you can request it, online from either of the credit bureaus, for a minimal charge.
Check out this infographic for everything you need to know about your Canadian credit score.
Why is Your Credit Score Important?
Your credit score carries a significant amount of weight when creditors decide whether or not to lend you money. If your credit score is too low, they may decide the risk is too high and you might not be approved for mortgages, loans, or other credit products. If your credit score is high, it will be easy for you to borrow money and you’ll probably get the best interest rates available.
Surprisingly, other people can see your credit report too. If you are looking for a new job, you should know that employers can request your credit information and use it in their hiring decisions. However, this is not the case for all jobs in all industries.
Landlords also request credit reports for potential tenants, using the information to predict whether you will pay your rent consistently. Insurance companies may also request access to your credit file before providing you with a policy.
How Does Debt Affect Your Credit Score?
Since debt-load is a big part of your credit score calculation (30%), the amount of debt you have can and will impact your credit score.
When it comes to using your credit, you should always try to stay under 30% of your total limit. For example, if you have several credit cards and a line of credit, with a total limit of $10,000, you want to try to use less than $3,000 at any given time. If you are regularly carrying a higher amount, it could have a negative impact on your score.
On the other hand, debt can also be a good thing for your credit score. If you owe money, but you are making your payments on time and adhering to the terms of your agreement, your credit score will likely improve over time. Whenever you use credit wisely and pay it off consistently, it will impact your credit score in a positive way.
What About Credit You’re Not Using?
If you have revolving credit in your file, you should be using it. It seems a little counter-intuitive, since paying off debt is a good thing, but that $10,000 credit card sitting idle, could be costing you points on your credit score. The trick is to use it responsibly, paying at least the minimum payment and preferably the entire balance, whenever possible.
Click here to learn the secret behind your credit card’s minimum payment.
What Should I Do About Debt That’s Affecting My Credit Score?
If your debt is having a negative impact on your credit score, it doesn’t have to be that way forever. As you pay down your debt and keep other factors in check, your credit score will begin to increase. Negative information can stay in your credit file for 6-10 years, depending which province you live in, but lenders often prioritize your most recent information. There are no quick fixes, but when you take measures to reduce your debt, it will have a positive effect on your credit score.
If you can, liquidate assets, increase your income, cut down on spending, and budget wisely. This way you’ll be able to put more money toward paying down your debt. If you’ve missed payments on a particular account, try to pay that one off first. When one account is paid off, take that money and put it toward the next account you plan to tackle. In this way, you can pay higher amounts off, as time goes on.
Want to know how bad credit affects your daily life? Click here.
What if I Can’t Pay Off My Debt?
Sometimes, unfortunate circumstances occur. Whether you’re in debt due to unemployment, underemployment, or illness, or you’ve simply made some poor decisions and your debt has become unmanageable, there are several options available to you:
Debt Consolidation Loan
If your income is sufficient, you might be able to consolidate your debts. By combining several debts into one loan, you can reduce your interest and payments to an amount you can handle and pay off what you owe faster.
Here’s what to do if your application for a debt consolidation loan gets denied.
Debt Consolidation Program
If your credit score has been affected by high debt, you may not be able to obtain a consolidation loan. If you enter a Debt Consolidation Program, a credit counsellor might be able to work with you and your creditors to reduce payments and/or interest and combine your accounts into a single payment.
To discover the ins and outs of debt consolidation, watch our video.
Debt Settlement Program
If you can’t afford to make your payments and you have accounts in collections, a debt settlement specialist can help you reduce your total debt load.
If you have a large debt, between $5000 and $250,000 and have assets you want to keep, a licensed Insolvency Trustee may be able to negotiate a consumer proposal between you and your creditors. With this option, your debt is reduced, interest no longer applies, and creditors stop hassling you.
In the most challenging debt circumstances, claiming bankruptcy could be your best option. When you choose this option, you will work with an Insolvency Trustee. There will be no more creditors calling and actions against you, such as wage garnishments, and lawsuits will end. Most of your debt will be absolved and you will be able to start fresh.
These options require careful consideration, as there are costs and benefits associated with each one. If you are struggling beneath the weight of your debt, and can’t see a way out, talk to us about the debt consolidation options available to you.
Rebuilding Your Credit
Once you’ve dealt with your debt, it’s time to begin rebuilding your credit and increasing that credit score. Start using credit, with limits you can manage, and pay it back as agreed. Fortunately, your credit score isn’t set in stone, and you can always take steps to improve it.
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Margaret Johnson is in the business of helping Canadians tackle their debt, deal with credit issues, and regain control of their finances.