What Is A Credit Score And Why Does It Matter?

Your credit score is incredibly important. Not only do potential lenders look at this score as a marker of your ability to responsibly manage credit, but it may also be checked by prospective landlords and even employers.. Let’s take a look at how credit scores work, why credit scores are important, and how to build good credit in Canada.

What is a credit score?

A credit score is a three-digit number that banks, credit card companies, and other financial institutions use to evaluate your creditworthiness, or how likely you are to pay back debt. This includes personal loans, lines of credit, mortgages and credit cards.

Your score is calculated through careful analysis of information in your credit report by credit bureaus. The two main credit bureaus in Canada are  Equifax and TransUnion. Financial institutions use this information to help make decisions about the services and products they offer you, such as interest rates and insurance premiums.

Your credit score is affected by your historical use of credit: how much you have, how long it takes you to pay back, what type you have, and how long you’ve had it. 

As the illustration shows, your credit score is affected by payment history, credit utilization (how much credit you use out of what is available to you), your credit history, credit mix (types of credit), and your number of credit inquiries.

Credit scores typically range from 300 to 900 depending on the scoring model, and the higher your score is, the easier it may be for you to access these financial products and services. Credit scores, in the eyes of financial institutions, reflect your behaviour when it comes to credit. For example, missed or late payments may lower your score, while being in the habit of paying your bills on time may improve your score. 

Why does my credit score matter?

Your credit score is a measure of trust: the higher your score, the more trust lenders and institutions will have in your ability to pay them back. A good credit score can help you improve your financial well-being and make getting a mortgage, getting a loan to buy a car or fund a renovation a lot easier (and cheaper!)

As the diagram above shows, your credit score is affected by payment history, credit utilization (how much credit you use out of what is available to you), your credit history, credit mix (types of credit), and your number of credit inquiries.

What can I do to help improve my credit score?

If you credit score is low, here are some great habits that could help improve it:

1. Pay your bills on time. Set up pre-authorized payments on all of your bills, especially the ones that report to the bureaus (mortgages, student loans, auto loans, and credit cards). These can also include your utilities, cell phone, insurance, etc. Your payment history accounts for about 35% of your credit score.

2. Watch your credit utilization. Using a lot of the credit that you have available to you can signal to potential lenders that you’re struggling financially, which can raise a red flag when they’re considering whether or not to lend to you. For this reason, it is recommended you keep your credit utilization below 30%. As an example, if you have two credit cards with a limit of $5,000 each, meaning you have $10,000 total credit in your name, you should aim to keep your combined balances below $3,000 at any given time.

3. Diversify your credit mix. Potential lenders like to see that you can handle multiple types of credit, so if you only have one sort of credit product, it could be a good idea to take on some different types of credit to help diversify your credit mix. There are three types of credit: revolving (eg credit cards and lines of credit), instalment (eg personal loans) and open (mortgages, utility bills).

Some examples are:

• Reporting your rent payments: Including your rent payments on your credit report is an easy way to add a new credit line to your report without taking on any extra debt. Think about it: if you’re already making your rent payments on-time every month, then why not get extra credit for doing so? Get started on reporting your rent with Borrowell Rent Advantage^™. This is reported as an “open” tradeline on your credit report.

• Switching to a monthly cell phone plan: If you’re on a pay-as-you-go plan, you might want to consider switching to a monthly plan so that your payments get included on your credit report. However, make sure to check with your cell phone provider that they do report to the credit bureaus before signing up, as not all do. Cell phone plans are reported as an “open” tradeline on your credit report.

• Using Credit Builder: Borrowell Credit Builder is a subscription-based credit building product, where you make monthly payments that are reported on your credit report to help you build your credit history, payment history and credit mix. At the end of the term, you’ll also get a lump sum back from the payments you made. This is reported as an instalment tradeline on your credit report.

The Bottom Line

There are lots of different factors that impact your credit score. Being aware of why it matters and building good financial habits is a great first step! Don't forget to track your progress - you can sign up for Borrowell to check your free credit score in under 3 minutes. You'll receive weekly updates to your score and report, and checking the Borrowell app won't impact your score. You can also find which financial products match your profile and your likelihood of approval.