20-year financial veteran Paul Murphy breaks down how the major credit bureaus work, showing how your credit score is calculated in Canada.
Five major factors go into how your credit score is calculated in Canada.
1. Your payment history
2 . Amount of utilization
3. Length of time of credit history
4. New credit
In this resource, I’ll walk through each one, showing you how credit scores are calculated in Canada, what you can do to improve your credit score, as well as offer advice for timing different credit applications.
There are a lot of articles out there about how to build credit and how to quickly improve your credit score.
The advice in this article is all gathered from my experience working at 4 Pillars, where we’ve helped thousands of Canadian families rebuild their credit.
With our clients, we’ve seen how a bad credit score can manifest into lower confidence and deflated self-worth. These clients fixate on their credit rating score and how to improve it.
A bad credit rating is not as bad as it seems.
It’s a pretty easy thing to fix and it’s never too late to start rebuilding your credit. It doesn’t take that long if you have a good overall plan.
So how is your credit score calculated? What are the big actions you can take to improve your score?
I recently sat down with David Moffatt from 4 Pillars’ Halifax office and managing partner Troy Tisserand on our 4 Pillars’ podcast Beating the Debt Game. I’ve summarized what we talked about below. If you prefer to download and listen to the podcast episode, you can listen here.
How is your credit score calculated in Canada? It comes down to these 5 magic factors.
In Canada, there are two main credit bureaus Equifax and TransUnion.
Equifax and TransUnion are like the Coke and Pepsi of the credit reporting industry.
They offer similar types from reports from many similar sources of information but generally, lenders in Canada will prefer one over the other. These credit bureaus gather all of our information (from the courts, credit cards, debt collection) and then sell that information to different lenders.
It’s up to you, the consumer, to make sure these reports are accurate. They could have your wrong address, wrong employee history, or other errors.
When we work with clients, we typically look at both Equifax and TransUnion as often different information is reported and sometimes one will report an error, the other shows it as correct.
We recommend going directly to Equifax and TransUnion to fix any errors and to check your credit score (rather than the easy-access tools that offer to do this for you).
So what is a good credit rating in Canada? If you’ve pulled your credit report, here is a breakdown of what a good credit rating in Canada looks like.
750+ is an excellent credit rating. You’re a banker’s dream! This is considered a good credit score in Canada. Why are you even reading this article?
700-749 is a good credit rating. Mortgages, boats, cars, the world is yours to borrow! Anything above 700 is considered a very good credit score.
650-699 is a fair credit rating. You’re a bit risky but many lenders will tolerate this risk.
600-649 is a poor credit rating. Based on your history, many lenders will not accept your credit applications. But there are actions you can take to improve your credit history.
Below 600 is a bad credit rating. You’ll struggle to get loans or only get access to overpriced credit. You’ll need a plan to rebuild.
The credit scoring system is a mathematical model. Only the credit bureaus know exactly how they score different items and each bureau might rank certain areas higher. But we do know the general categories they look at and the five different areas that are used to determine a credit score in Canada.
1. Your payment history
Your payment history makes up about 35% of your credit score in Canada.
Lenders are trying to predict future behavior. They trying to see how often you are making your payments on time across all of your loans, bills, and so on. The lender might look at bankruptcies and delinquencies here but mostly it is about whether you’re making payments on time.
Most consumers think that payment history how a credit score is calculated in Canada. But your payment history is only 35% of your score.
Missed a payment? Had a stretch of debt trouble? Don’t worry. Remember, a credit score is trying to predict future behavior. The past is the past and lenders are more interested in the future. The model is trying to determine this question: if we lend money to this person today how likely would they pay back that loan tomorrow and into the future?
As a result, your payment history is more weighted to recent activity. This often surprises our clients. When they are looking at things like consumer proposals or bankruptcy, they get fixated on missed payments and the past and think that they’ll never get a good credit score again. This is simply not true! What’s happened in the past is in the past and there are always steps you can take to always rebuild your credit score.
If you have had issues in the past (maybe you had trouble paying bills after losing a job) or even consumer proposals and bankruptcy (maybe you went through a divorce or lost your business), your credit score can be re-established by following the right process.
2. Amount of utilization
Lenders look at how much you owe: credit cards, overdrafts, lines of credit, the balances we have on our loans. It’s worth about 35% on your credit score. At 70% of utilization, you are in the red zone. As your balances grow, this puts downward pressure on your credit score.
For example, let’s say you have a credit card with a $1,000 limit and you go and spend a bunch and you bring the balance to $900. What are the chances a creditor is going to give you another credit card? Not high. This is your amount of utilization: you’re using too much of the credit available to you.
The amount of utilization looks at an overall picture. It doesn’t specifically drill down into one credit card but takes an average of all your credit available. It’s a formula the credit score spits out.
Try to keep your credit balances month-to-month at zero. This is going to have the highest impact on rebuilding your credit.
When we work with new clients who are deep in debt, it’s often utilization that is harming them the most. They fall into the myth that a good credit score is created by making all their payments on time.
As a result, they are paying the minimums on different credit cards, taking out new loans (but paying them on time), and performing a credit juggling act. But making payments on time is only 35% of the battle, so we need better planning to keep those balances low and reduce our overall utilization of our credit.
It’s good to remember that credit reports use two types of credit: R and I.
R = revolving credit. Your balances change every month. It’s a moving target. But the balance is tracked and impacts your credit rating.
I = installment loan. Think of a car loan. It’s a set amount. You pay a certain amount every month. And if you make all the payments, you get a big boost in your credit rating. But because it is a big amount (say a new car), often your credit rating will take a bit of a hit once you take on a new installment loan. This isn’t a bad thing. Just something to remember when you are making big financial decisions. If you’re applying for a mortgage, for example, you shouldn’t buy a car the week before!
Knowledge of how credit scores work can save you thousands of dollars (such as getting a better rate for your mortgage). When getting loans, keep your revolving credit low so that you are not using up your utilization. In other words, keep those credit cards low before buying a new car or applying for a mortgage.
This is not to discourage you from taking out loans! Loans are an important part of rebuilding your credit rating. And once you get past the 50% repayment mark of your loan balance, you’ll get a big boost to your credit score.
3. Length of time of credit history
This is worth about 15% of your credit score in Canada. How long have you had credit? The longer you’ve had credit, the more you’ll see your credit score bumped up.
For example, let’s say you’ve had the same credit card for 20 years.
You’ve been an angel and paid your balance every month. If you cancel that credit card, you’ll see a hit of about -75 points.
This is because all those years of diligent payment history have been wiped out. This also shows that if you’re applying for a loan, don’t cancel any cards before you apply. And if you have average credit, avoid chasing the latest offers for points or money-back cards that come in your mail.
When trying to build your credit rating, don’t cancel your credit cards. If you struggle to stick to a budget, you can just cut up your credit cards and don’t use them. And if you have fees, consider reaching out to the credit card company you currently have and ask if they have a different card with no fees in order to maintain your long payment history.
On the flip side, sometimes our clients also get obsessed with not borrowing any money. After they go through a financial crisis, they might get very allergic to any type of credit. As a result, over time they don’t have credit cards, car loans, or any payment history.
One client we worked with had rebuilt their financial life and was debt-free, except for their mortgage. But when their mortgage was up for renewal and they needed to find a new lender, the lack of any payment history and lack of any other credit products made it difficult for them. The point is that to have a good credit rating, it’s not just about not having debt. You need a profile and history.
4. New credit
The fourth factor that’ll go through is what we call new credit. New credit is worth about 10 percent of how your credit rating is calculated.
As we apply for different types of credit, those applications are tracked on our credit bureau and we call that a hard inquiry. A hard inquiry is you making an application for credit (such as applying for a new credit card or loan) and the lender pulls your credit report. A soft inquiry is you, as the consumer, requests your credit score or report for your own personal use. A soft inquiry doesn’t impact your score.
This means we do not want to be applying for too much credit within a given calendar year. The general rule is that we only want to be applying for credit more than four times a year over at the calendar year January 1st through to December 31st.
To protect your credit rating, you also do not want to be applying for too much credit over a short period of time. And you only want to apply for credit you’ll actually get–don’t be tempted by the latest offers in your mail!
Getting a new car can trigger a lot of hard inquiries. Often, car dealerships will ask you if you want to be pre-approved and can make multiple hard inquiries, pulling your credit report.
Don’t let car dealers pull multiple reports. Do your test drives and decide on the car you want to buy. Only then you can give them permission to do that hard inquiry.
This is about you having different types of credit. It’s worth about 10% of your credit rating, rounding out your score. This shows lenders that you can handle different types of credit products. For example, “oh, he is using a line of credit, a few credit cards, an auto loan, and so on.”
This is a rather minor factor. If you already have an excellent credit score, you can consider adding a mix of credit products to round out that score.
Your credit score is important but only part of the picture
It’s important to remember that your credit score is only one part of what lenders are looking for. They are also looking at your income, the assets you own, the stability of your job, and your credit rating, giving them a more complete picture of what you are like as a lender and the likelihood you will pay back your loan.
In our culture, it’s common for people to desire to look wealthy rather than actually be wealthy. While driving a Lexus might make you appear rich to your neighbors, if you can’t afford it and are prioritizing a massive car payment rather than building assets (like paying down your mortgage), this can harm your financial future.
Our advice to our clients is to not obsess over your credit score. In order to have a good credit score, you need to master the basics: budgeting, building a savings account, prioritizing assets over car loans, and protecting your financial future.
All of these actions will naturally help you become the type of applicant that lenders are looking for. Rather than being fixated on your credit score or worrying about missing a payment, you’ll be building a really solid foundation for the future.
Rebuilding your credit with 4 Pillars
We specialize in helping Canadian families navigate tough financial times. Credit rebuilding is one part of how we help.
One of the credit cards we use to help our clients rebuild their credit is called Plastk. Visit their website to apply for their secured credit card here.
To learn more about how we guide you through debt decisions (including consumer proposals, consolidation loans, and navigating insolvency), book a free meeting with one of our 60+ offices in every Canadian city and town. This meeting can be done virtually as well!
Not ready for a meeting? Grab a free copy of my book, Beating the Debt Game, for a fast tour of the debt industry and how any Canadian can make the debt system work for them, instead of against them.