What is Credit and Why is it Important?

Credit is an important tool that reflects your financial wellness and ability to manage money. A good credit score helps you qualify for loans, credit cards, and even jobs or apartment rentals. Good credit will enable you to secure favourable interest rates, ultimately saving you money and making it easier to build wealth. 

Whether you plan to use credit or not, building a solid credit score opens financial doors for you and makes many aspects of your life easier. Whether competing for a rental in a crowded market, buying your first car at an affordable rate, or securing a prime mortgage for your dream home, having a good credit score will give you a leg up.

This guide will answer all of your questions about the different ways your credit score can affect you.

What Does Credit Mean?

Credit is money loaned to you under the assumption that you will pay it back at a predetermined interest rate. Your credit score is a number that indicates your likelihood to pay what you owe and your ability to do so on time. In other words, your credit score is a reflection of your creditworthiness.

The higher your credit score, the more appealing you’ll be to lenders, giving you a better chance at qualifying for products like loans and credit cards at favourable interest rates. A low credit score will make it challenging to qualify, relegate you to higher interest rates, and could even affect your ability to rent an apartment or secure a job. 

There’s no way around it. Building credit and maintaining a positive credit history will make it both easier and cheaper to borrow money.

7 Scenarios in Which Credit Plays an Important Role

You might be surprised to learn the myriad of ways that your credit score and credit report impact your daily life. Beyond the obvious, like credit and loan applications, your credit score has a bearing on your ability to rent an apartment and potentially even secure a job. Needless to say, working to maintain a positive credit history is highly beneficial. 

Here are 7 scenarios where your credit score plays an important role.

Credit Card Application

Your credit score affects not only your ability to qualify for a credit card but also the terms of your credit card agreement. Borrowers with high credit scores often have access to lower interest rates, higher credit limits, lower account fees. A high credit score can also grant you access to more exclusive credit cards with better perks, such as higher cash-back rates, lower transaction fees, and better rewards programs.

A low credit score could prohibit you from qualifying for a credit card or result in cards with extremely high interest rates.

Mortgage Applications

Having a good credit score can help you qualify for favourable mortgage rates, making it more affordable to borrow money and enabling you to keep your monthly payments low. Borrowers with low credit scores will pay higher interest rates and may even need to put down a larger downpayment to secure a mortgage. 

If your score is too low to qualify for a mortgage through major banks, you may need to borrow through an alternative lender. These lenders often offer interest rates and may charge additional fees that a bank wouldn’t.  

Car Loans

Financing a vehicle can be a great way to build credit, but it may be challenging to qualify for a favourable auto loan if your credit score is on the lower end. Expect to pay higher interest rates and make a larger down payment if you do qualify. 

Once again, borrowers with high scores will have access to more favourable terms, like those “zero money down” or “0% percent financing” promotions you see advertised on television. With access to lower interest rates, you’ll spend much less money overall on your new vehicle. 

Rental Applications

Most landlords will require a credit check as part of your rental application. They use your credit score to determine your creditworthiness and indicate whether you’re likely to pay your rent on time. Your specific credit rating is as important to them as a clean credit history with no late payments, delinquent accounts, or bankruptcies. Still, generally, a higher score gives you a better chance at securing a rental.

Employment Applications

Some employers perform credit checks on job applicants. This is most common for roles that would involve managing money or having access to a company credit card, corporate vehicle, or other valuable assets. 

You can still get hired if you have a low credit score– ultimately, employers are more concerned with bad marks like late payments, delinquent accounts, bankruptcies, or property liens. In other words, it’s more important to have a clean credit report than a high credit score. 

Student Loan Applications

Student loans are a common way for young folks to build their credit. The federal Canada Student Loan Program (CSLP) does not require students to undergo a credit check to qualify. Instead, these loans are granted based on financial need. However, a credit check will likely be needed if you wish to secure a student loan through a private lender.

Insurance Premiums and Utilities Accounts

Your credit score may affect your ability to qualify for insurance premiums or open utility accounts such as electricity, internet, or gas. While you should be able to open a utility account regardless of your credit score, you may have to jump through some extra hoops to do so. Often, individuals with lower (or non-existent) credit history may be required to pay a security deposit when opening an account for the first time. You may be able to have this deposit returned to you after a long period of making on-time payments.   

Your credit score comes into play regarding insurance policies as well. Borrowers who purchase homes with less than 20% down must buy mortgage default insurance. If you have a credit score below 600, you might not qualify for an insurance policy, affecting your timeline for purchasing a home. 

In some provinces, you may be subject to a credit check when taking out an auto insurance policy. If you live in one of these provinces, premiums may cost more for those with low credit scores. 

What is Considered Good Credit and Bad Credit?

Canada uses a credit rating system that ranges from 300 to 900. The better your credit, the higher your score. A credit score below 660 is considered below average, while a score above 713 is considered “good.” 

Here’s a breakdown of how credit scores are categorized according to different ranges.

• Excellent: 741 - 900

• Good: 713 - 740

• Fair: 660 - 712

• Below Average: 575 - 659

• Poor: 300 - 574 

Generally, a score in the “fair” range or higher means you’ll have a good chance of qualifying for standard rates and terms from different lenders. If your score falls in the “excellent” range, you’ll be able to secure the best interest rates and loan terms and have access to products that are exclusive to individuals with excellent credit.

If your score falls in the “below average” or “poor” range, you will have some work to do. You may still be able to qualify for some credit products, but you’ll be facing higher interest rates and stricter terms. You can likely raise your credit score in a relatively short time by making minor adjustments to your financial habits and using your credit strategically. 

What Are the Different Types of Credit?

There are a few different types of credit, and they each work a little bit differently. Having a diverse credit mix shows lenders that you can manage your money through several different scenarios and can help improve your credit score. Here’s a look at the three different types of credit.

Installment

Installment loans are loans for a fixed amount of money that are repaid on a predetermined payment schedule at a fixed interest rate. Auto loans, student loans, and mortgages are typical examples of installment loans. With installment loans, you know exactly how much you’ll pay each month and for how long. 

Revolving

Revolving loans are loans with a credit limit that you can borrow against. If you run up your balance, you can pay it down and then spend it again. The most popular types of revolving loans are credit cards and lines of credit. These loans are flexible because you can pay what you want, as long as you meet the minimum payment each month. However, your credit score may be affected if you regularly max out your credit.

Open Accounts

Open credit refers to accounts that don’t have a fixed limit. Your utility accounts, like water or electricity, are common examples of open credit accounts. The lender provides a service with the expectation that you will pay at the end of each billing cycle. There is no limit to how much of the service you can use, and the amount of your monthly bill may vary from month to month depending on how much you use. 

What Are the Components of a Credit Score?

Your credit score is calculated based on various factors, including your history of on-time payments, the age of your accounts, the amount of credit utilized, and more. Here’s a closer look at the components of your credit score. 

Payment History

Your payment history makes up 35% of your credit score– more than any other category. This is why it’s so crucial to make all of your bill payments on time. 

Amounts Owed

The amount of money you owe, also known as your credit utilization, accounts for 30% of your credit score. Lenders look down on borrowers who carry a high rate of debt to credit as it suggests that they may struggle to manage their finances effectively. A low credit-to-debt ratio will result in a higher credit score. 

The general rule is to use no more than 30% of your available credit at any given time. So, if you have a $1000 credit limit, don’t carry a balance of more than $300. 

Length of Credit History

The length of your credit history makes up 15% of your overall credit score. The ages of your oldest credit account and your newest account and the average age of all your accounts all determine this aspect of your score. Lenders like to see that borrowers can maintain healthy credit accounts long-term—generally, the older your accounts, the higher your credit score. 

Credit Mix

Credit mix refers to the different types of credit accounts that you hold and makes up 10% of your score. Lenders like to see that you’re capable of managing different types of loans over time. Incorporating a mix of installment and revolving loans can help you boost your score if you make on-time payments.

New Credit

Your recent credit inquiries account for 10% of your credit score. Too many credit inquiries in quick succession could indicate that you’re desperate for money and act as a red flag for lenders. This is why you might see a slight dip in your credit score any time you apply for a loan. 

Be mindful about when you authorize hard credit inquiries; if you’re trying to spruce up your score to apply for a mortgage, don’t also apply for a car loan at the same time. 

Is a FICO Score the Same as a Credit Score?

Not all credit scores are FICO scores, but your FICO credit score is a handy metric.

FICO is a popular credit scoring formula that was created by the Fair Isaac Corporation (FICO). It is commonly used by lenders to determine a borrower’s creditworthiness. Your FICO score is calculated based on the factors listed above as reported by the major credit reporting agencies, TransUnion and Equifax. 

The FICO formula is just one approach to calculating your credit score, but it is quite popular. Depending on where you access your credit score, you may be viewing the FICO score or a number calculated using a different method– each credit reporting agency uses its own formula. The credit scores reported using different methods won’t always be the same, but they should be very similar. 

What is a Credit Report?

Your credit report is a document that summarizes several aspects of your finances to illustrate how financially responsible you are. It summarizes all of your open accounts, the amount of debt you currently carry, the number of recent credit inquiries you’ve made (or authorized), and your payment history. 

If you’ve made late payments, closed accounts, or have accounts in collections or charged-off accounts, your report will reflect this information too.

All of the data presented on your credit report is used to determine your overall creditworthiness and assign you a suitable score.

How Often Should I Monitor My Credit?

You should make a habit of monitoring your credit regularly so you can spot changes in your credit report and keep an eye on your financial health. Credit monitoring can help you spot potential identity theft, track your progress toward future financial goals, and stay on top of errors or mistakes in your report.

The ideal interval at which to monitor your credit depends on what you feel is manageable. Borrowell makes it easy to view your credit score and your credit report for free at any time. Our weekly credit score reporting and monitoring makes it easy to stay on top of your current score.