Friday, May 28, 2010

What Makes Up A Credit Score?

Last month I wrote an article about how to read your Credit Report.  Since then, I’ve had a few people ask me about the credit scores themselves.  It’s an important topic, so I hope the following can help everyone understand how the credit bureau agencies create your credit score.

In Canada there are two credit bureau agencies that collect credit information and establish credit scores: Equifax and TransUnion.  Every time you apply for credit and make or miss a payment on a bill, that company reports that occurrence to the credit agencies.  With that information the credit agencies determine your credit score.  A credit score is a 3 digit number that represents your borrowing and repayment history, with 300 being the worst and 900 being the best.

What influences your credit score?
The credit agencies use a formula to determine your credit score.  This formula takes into account the following:
  • ·    Payment History – Do you make your payments on time for credit cards and loans?  Not missing payments shows an ability and willingness to handle your debt.  Missing payments will lower your score.
  • ·    Amount Owing – How much money have you borrowed, and how much of your accessible credit are you using?  Are your lines of credit and credit cards maxed out or only used a bit?  Maxed out credit lowers your score.
  • ·    Account History – How long have you had these loans?  Having a loan for a long time without missing payments is good for your score.  
  • ·    Recent Inquiries For Your Score – How many times have companies asked about your credit score in the past year?  If you have more than one application in a year, this lowers your score a bit each time.  This includes vehicle financing companies, furniture financing, and credit card applications.
  • ·    Type of Credit Used – Do you have bank loans and bank credit cards or store brand credit cards?  Bank loans and credit cards get a better score than store credit cards because they do a more thorough credit investigation when approving loans and cards.  Associated with this, many store cards, because of approving almost everyone, have interest rates of over 26%, while many bank cards are around 18%.
  • ·    Collections or Bankruptcies – Have you had any bills sent to a collection agency or have you declared bankruptcy?  Any bill, Telus, Atco, Bell… that is sent to collections will lower your score.  A bankruptcy really lowers your score, and often makes it so a bank won’t lend to you for at least 2 years.
There are places that will lend to you if you have a low credit score, but usually your fees and interest charges will be much higher than if you have a good score.  A score of 620 or below usually means a person is high risk and most banks and credit unions will not lend to someone with that low of a score unless there is a lot of collateral or a co-signor with a good score.  620 to 680 is considered an average credit score, and will result in your lenders asking a fair number of financial questions to make sure you can repay the loan.  Above 680 is considered to be good credit or low risk, so these people may receive a lower rate, less fees, or fewer conditions for various loans.

Young adults often over borrow, especially in college, and this negatively impacts their rating for quite a while, as most credit reports stay on your credit score for about 7 years.  Another common mistake is to not make a payment on a credit card for 3 months and then pay it off completely.  Meanwhile three months of delinquent payments are reported, lowering the score.  It doesn’t matter that the whole thing is paid off, there were delinquent months and that shows up in your history.

Related to the late payments, some credit cards (mostly store cards) report everyday while others report monthly (most bank or CU cards).  For the daily reporting cards, this means if you are one day late your credit score will have a delinquent payment showing on it.

So, my recommendations to earn and keep a good credit score are:
  • Get only 1 or 2 credit cards. Use them, but pay them off quickly.
  • Do not miss payments on anything.
  • Do not max out your available debt.
  • Check your credit report out once a year.  You can order it here.
If you have any questions about credit scores, let me know and I’ll try to answer them.  It’s an important topic that not enough people know about.  Jerry


  1. I was aware of several points but not all. Really enjoyed the article.
    I guess I wonder what the point of getting your credit rating is exactly if you already know you keep up on all your responsibilites? Why would we require that number?

  2. Arlene, good questions. There are a few different reasons as to why you would want to keep track of your credit rating:

    1.Not all lenders/payees update their information as they should. There are many cases of telephone or electric companies reporting someone as late or delinquent even when they are not. And some banks don't always clear up their reports right away either. Student loans in particular are known for this. By checking once a year, you will know if your information is accurate.

    2.Identity theft and fraud can take a real toll on your credit rating. They may not steal your current card, but they may apply for one or two in your name, run them up and never pay. Often the only way someone finds out this has happened is when they apply for a loan and find out their credit rating is in the pits. By checking once a year, you are protecting yourself from some of these activities. You will see every credit card or loan that is in your name. Unfortunately, much of this fraud is committed by former spouses or by children.

    So, Arlene, even if you pay everything on time, knowing your credit score and seeing your credit history once in a while is really a good protection for you. It generally may cost around $20 to $25/year to check it online. I personally wouldn’t do the monthly monitoring service, as I think it costs quite a bit, but I do buy my history once a year.


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