Understanding your budget and credit

Understanding your credit is a great way to build a financial foundation. Your credit can influence your ability to buy a home, finance a car or make other big, exciting purchases.

Checking your credit score and report regularly contributes to your financial health and, over time, could help you discover any weak areas that need to be addressed. Plus, understanding your credit may help you access better products and services at lower rates. It may also be the key to being able to purchase a new car or to get a lower mortgage rate on a new home.

Why is having “good credit” important?

The term “good credit” refers to having a healthy credit score and credit report, and having a history of paying bills in a timely manner. Poor credit, on the other hand, is often reflected by a low credit score and a history of unpaid or late credit repayments on your credit report. People with “bad credit” may find it difficult to get approved for loans or credit cards with low interest rates. You can prioritize your financial health by ensuring you don’t miss loan or credit payments. Paying off your credit card balance before the due date will prevent interest from accumulating; although, making the minimum payment—if you’re unable to pay it back in full— is the second-best option and won’t lower your credit score.

What is a credit score?

A credit score is a three-digit number based on your credit file, payment history and other factors. It helps potential lenders and creditors weigh your “creditworthiness”, or your likelihood of repaying financial credit based on your history of repayments.

For example, a potential landlord could want to know whether or not you will pay rent consistently and on time, and may check your credit score to make sure you’re responsible with credit. A company offering loans or lines of credit will be interested in your ability to repay the loan, and may check your credit score to assess the “risk” in approving you for a loan.

What number should I aim for?

According to Equifax, a credit score of under 660 can generally be considered poor or fair. A good credit score falls between the 660-724 range, while a very good credit score lies between 725-759. A score of 760 and above places your credit score in the excellent category. While Equifax’s scoring model may be helpful to consider, it’s important to remember that ratings may vary depending on the model, and other scoring models may rate scores differently.

Keeping your credit in good standing allows you to borrow the money for bigger purchases, such as cars or houses, based on your agreement to pay back in the future or over time. Having good credit could increase your access to lower car insurance rates and lower interest rates on your credit card.

How is my credit score determined?

A credit score is calculated by credit bureaus, or private companies that record and report data about your credit history and usage. Canada has two main credit bureaus, Equifax and TransUnion, which receive information from banks, credit card companies and collection agencies in order to create your credit report and calculate your credit score.

When calculating your credit score, credit bureaus will factor in your:

• History of on-time payments

Your payment history makes up the largest portion of your credit score. While a history of on-time payments will improve your credit score, missed payments can impact your perceived “creditworthiness” and, as a result, cause your credit score to go down. Setting reminders on your phone or signing up for pre-authorized debit payments may be helpful to maintain a regular payment schedule.

• Credit utilization ratio or debt-to-credit ratio

Your credit utilization ratio, also known as debt-to-credit ratio, is the second biggest factor involved in the calculation of your credit score. It refers to the amount of total available credit you have versus the amount of used credit. Creditors want to see that you can manage your credit responsibly and that you’re not frequently reaching or exceeding the limits on your credit cards.

The lower the credit utilization ratio, the better your credit score will be. To keep building or maintaining your credit score, you’ll want to try to use under 35% of your credit. For example, if your limit is $10,000, try to avoid exceeding a balance of $3,500.

• Unpaid balances owed or debt

Having unpaid debt can hurt your credit score, particularly when the debt is sent to a collection agency, which is a company that pursues and recovers unpaid debts. A creditor will transfer the debt over to a collection agency in order to help track down the money owed to them. Once your creditor involves a collection agency in your debt, your credit score will decrease.

If you find yourself unable to make a debt payment, communicating with the creditor or company to whom you owe the debt is often the best next step. Contacting your lender will not only prevent them from reporting a late payment to a credit bureau, but it may allow them to help you find an alternative solution. You and the creditor can discuss the options available to you, such as loan extensions, interest rate reductions and even payment plans, which would allow you to make smaller payments in installments.

• The length of your credit file

A person with eight years of credit will be at a significant advantage compared to a fresh high school or college graduate with only eight months of credit. A longer track record of repayments ultimately helps your “creditworthiness” since creditors have more credit history to help them confidently evaluate the “risk” in offering you credit.

• History of bankruptcy

Filing for bankruptcy could severely affect your credit score and drop it to the lowest possible rating. Lenders and insurers are less likely to lend you credit after you’ve filed for bankruptcy, although there are ways to rebuild your credit score even after a bankruptcy.

• Types of credit borrowed

Rather than having all your credit on one credit card, consider having a “credit mix”. A credit mix happens when you spread your credit among different types of credit accounts, such as a mortgage, loan, credit card and line of credit. Along with your history of on-time payments and the length of your credit file, the types of credit you have are also considered when your credit score is calculated—although different lenders and scoring models may prioritize this information differently. Creditors want to see that you can responsibly manage various types of credit over an extended period of time, so having a credit mix may impact your credit score positively.

• History of hard inquiries

Hard inquiries are a type of credit check that have a minor negative impact on your credit score. Making a hard inquiry in itself is not an inherently bad thing. However, making multiple hard inquiries within a short span of time may give lenders the impression that you are in constant need of credit. With that in mind, it’s a good idea to avoid making several hard inquiries within a short period of time.

What is the difference between a soft inquiry and a hard inquiry?

While soft inquiries have no impact on your credit score, hard inquiries cause a slight decrease. When a potential lender accesses your credit score, it counts on your report as a hard inquiry or hard credit check. So, it’s good to be careful about how often you make hard inquiries—such as applying for credit—into your score. A soft inquiry or soft credit check allows you or someone else to check your score, but it doesn’t impact your score. Soft inquiries can happen for many reasons, such as when you apply for a mortgage pre-approval.

Why does my credit score vary from credit bureau to credit bureau?

Your credit score fluctuates according to your credit usage and the factors mentioned above. Your credit score may also vary slightly depending on which credit bureau you use to access it, since different credit bureaus often have different scoring models.

Different creditors and lenders prioritize the elements that make up your credit score differently, depending on what kind of information they’d like to view. Some creditors weigh your credit utilization ratio more heavily than your current outstanding debt, while other lenders are more interested in the type of borrowed credit or your history of hard inquiries. For instance, a car company may look at your history of repayments, while a bank may focus on other metrics, such as the length of your credit history or your history of bankruptcy.

How do I stay up-to-date on changes in my credit score?

Regardless of the slight differences in credit scores between bureaus, checking your credit score regularly through soft inquiries will help you better understand your overall financial health. One way to do this is by accessing your credit score and credit report directly from either Equifax or Transunion, or from free online services like Borrowell and Credit Karma.

What is the difference between a credit score and a credit report?

While a credit score is a three-digit number calculated based on your credit file, credit usage and other factors, your credit report describes your financial situation. It provides a detailed overview of your bank accounts, credit cards (and any outstanding balances), bankruptcies, student loans, mortgages, and other debt. Your credit report may also include closed chequing and savings accounts, debt that has gone to a collection agency, and any hard inquiries made within the last three years.

Organizations or individuals may factor in your credit report when deciding whether to:

• Raise your credit limit
• Approve your rental application
• Lend you money
• Consider you for a job
• Offer you insurance

Monitoring both your credit score and credit report will help you keep track of your spending habits, your credit utilization ratio and your general financial well-being. Checking your credit report and score at least once a year or more could help you detect any inconsistencies and ensure that your accounts are being reported accurately.

How can I improve my credit score and report?

If your credit score is not quite where you’d like it to be, there are plenty of tips to keep in mind. Here are a few things you can do to improve your credit score:

1. Pay your bills on time
• Your credit score will improve, decrease or stay the same, depending on multiple factors, such as your history of on-time bill payments. Your credit report shows whether you have any missed or late payments, how long they went unpaid and how often this happened. Paying your bills on time will avoid filling your credit report with missed or late payments, and improve your credit score.
2. Develop a plan to pay off any outstanding balances
• Having outstanding balances or debt on your accounts could negatively impact your credit score, so make sure to develop a payment plan or schedule. If you’re unable to pay a balance by the due date, consider contacting the financial institution to whom the debt is owed. They may be willing to discuss your repayment strategy and see if there are any alternative options available to you.
3. Diversify your types of credit
• Having a credit mix, or different types of credit accounts—such as credit cards, mortgage, lines of credit—can have a positive impact on your credit score. Creditors want to evaluate your ability to manage different types of credit rather than just one type of credit. Student loans, car loans and mortgages are classified as installment credit, because they are loans that give you a lump sum of money with the expectation that you will pay it back over a certain period of time. Making the required repayments will improve your credit score and suggest that you can responsibly maintain credit over time. Credit cards, on the other hand, are an example of revolving credit, since they allow you to take out different amounts of money each month and pay it back. Lenders will want to see that you can successfully handle both installment credit and revolving credit.
4. Avoid applying for credit with different lenders within a short timespan
• Since it requires a hard credit inquiry, applying for credit will negatively impact your credit score. Applying for too much credit within a short timespan will not only be noticed by potential lenders, but may also give the impression that you are living beyond your means and struggling to afford your current debt.
5. Close the newest credit card rather than the oldest one
• If you’re closing a credit card, consider closing the newest card, rather than the oldest one, in order to maintain the credit history of your oldest account. Potential lenders look at the age of your credit history, how long you’ve maintained your credit cards and the average age of your credit accounts combined. Keeping the older credit cards is often better, since creditors will want to see that you can manage credit over a long period of time.
6. Keep your credit utilization ratio low
• Your credit utilization ratio (or debt-to-credit ratio) refers to the amount of credit you’re using versus the amount of credit you have. If your credit usage is more than 35% of your available credit, that may suggest that you are overspending.

What to do if you have a “thin credit file”?

A “thin file” refers to a credit report with minimal information about your credit history, credit usage and other important data about your credit. When you haven’t previously taken out loans or a credit card, your credit report may not provide enough credit information for lenders to make decisions about lending you credit. In this case, you may find it difficult to find creditors who are willing to offer you the money you need.

If you’ve got a “thin credit file” and you need credit for a major purchase, consider cosigning a loan with someone you trust, such as a family member or partner. Cosigning with someone who has strong credit can help lower the interest rate on your purchase and help you get started on building your own credit. Another option is to get a prepaid credit card, which requires an initial deposit to secure your line of credit. After you’ve developed a paper trail of responsible credit management with your prepaid card, you’ll be able to build your credit score and be more likely to receive a loan, credit card and other forms of credit with better interest rates.

There are many benefits to keeping an eye on your credit score and report. For one, checking both regularly helps you gain a better understanding of what potential lenders see when they look at your file. Monitoring your credit score and report can also help you detect any incorrect information and recognize fraud or identity theft early, since you’ll be able to notice inaccurate data quickly and report it to your financial institutions.

Building a credit report with diversified credit and watching your credit score grow from fair to excellent can be incredibly rewarding. Plus, it's a great sign that you are incorporating healthy money habits into your daily routine, managing your credit responsibly and heading down the path of financial health and security.

The information in this blog is for information purposes only and should not be used or construed as financial or investment advice. Information obtained from third parties is believed to be reliable, but no representations or warranty, expressed or implied, is made by Questrade Group of Companies, its affiliates or any other person to its accuracy. 

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What you’ll learn:

• Factors that affect your credit score
• How to improve your credit score
• The benefits of having a good credit score as a first time home buyer

Getting ready to buy your first home? Understanding your credit score, how it works and why it’s important could help improve your credit score, making it easier to buy that first home. Let’s break down the complicated jargon to better understand credit scores and how they impact your financial well-being.

Whether you’ve been saving up for your first home, or you’re just researching your options, it’s important to understand the role your credit score plays in your financial journey. Developing healthy financial habits can help you improve your credit score and make sure you’re on track for any big, future purchases.

What is a credit score?

A credit score is a three-digit number that gives lenders a summary or representation of your credit file and whether you regularly pay your bills on time. Your credit score changes depending on your credit usage, credit payments and other factors.

Potential lenders look at your credit score to understand what kind of borrower you are. Your credit score can affect your eligibility for loans, credit cards and even apartment rentals. So, it’s a good idea to pay consistent attention to your credit score and credit report, and make adjustments to your credit usage if necessary.

The following factors can impact your credit score:

• History of payments
• Amount owed/outstanding debt amount
• How long each credit product has been in your report
• Carrying a balance on your credit cards or line of credit
• Reaching or surpassing your credit limit
• The types of credit you use
• Debts that have been sent to a collection agency
• Insolvency or bankruptcy

What are credit bureaus and what do they do?

Wondering how to access your credit score? You can view it by getting a credit report from Equifax or Transunion, the two main credit bureaus in Canada.

Credit bureaus are private companies that monitor and record your credit history and your history of repayment on your financial products. Credit bureaus receive information from the bank, credit card companies, and collection agencies in order to determine your credit report and overall score. Even utility companies can report your payments to credit bureaus, so paying your utility bills on time can also impact your credit score.

What is the difference between a soft inquiry and a hard inquiry?

There are two types of credit inquiries: soft and hard inquiries. Soft inquiries, also known as soft credit checks, have no impact on your credit score. A company may perform a soft inquiry to review your credit score when you apply for a mortgage pre-approval, or when you check your credit score with websites like Credit Karma or Borrowell. Hard inquiries, on the other hand, are formal reviews that are connected to credit applications, such as a new line of credit, a new loan, credit card or even a mortgage loan. Hard credit checks typically will lower your credit score a little bit because lenders want to be sure you’re not going from creditor to creditor applying for various credit products at once (which could be a sign of potential financial distress). Still, hard inquiries will only minimally impact your credit score, so there’s no need to shy away from applying for financial products when you need them.

How can I improve my credit score?

When it comes to your credit score—the higher, the better. According to Equifax, a good credit score lies between the 660–724 range, while a very good credit score falls between 725–759. An excellent credit score is a score of 760 and above.

Although there is no “perfect” credit score that will guarantee you the best rates, people with higher scores are more likely to get approved for loans, credit, and lower mortgage rates. If you’d like to take your credit score to the next level, there are many things you can do to improve it. Here are just a few:

• Pay your bills on time

Payment history is a significant portion of your credit score. Low credit scores are often due to late payments, which can remain on your credit file for many years. So, the best way to boost your credit score is to keep track of your bills regularly and pay them on time.

If you find that life gets in the way of paying your bills on time, pre-authorized payments may be a good option for you. Pre-authorized payments, or pre-authorized debits (PADs), happen when you agree to allow a merchant to automatically deduct an amount from your bank account or credit card when bill payments are due. Pre-authorized payments are a great way to guarantee that your bills are paid on time each month, as they remove the pressure of having to send each bill payment before the due date.

• Establish a good credit history

Credit cards can actually be an important factor in building good credit history, but they should be used responsibly. By using a credit card to pay for expenses and paying off your card balance in full before the due date, you’ll demonstrate your ability to maneuver credit responsibly. Establishing a history of on-time payments will improve your credit report and prove you are reliable to potential lenders and creditors.

• Keep your credit utilization ratio low

When looking at your credit report, creditors will consider your credit utilization ratio (or debt-to-credit ratio), which refers to the amount of credit you’re using versus the amount of credit that is available to you. For example, if you’re constantly running your credit card up to the limit, your credit usage may suggest that you are overspending or struggling with your current debt.

Generally, it is a good idea to keep your credit utilization ratio under 35%, which means if you have a limit of $5,000, you’ll want to use less than $1,750. For example: 35% X $5,000 = $1,750.

There is some value to saying “yes” when the credit card company asks to increase your credit limit. As long as your spending doesn’t go up, a credit increase would help you lower your credit utilization ratio and boost your credit score.

• Take the time you need

Building up a strong credit score can take time. It’s not easy to establish a lengthy history of on-time payments and responsible credit usage. If your credit score isn’t where you want it to be yet, don’t hesitate to take the time to improve it using the tips provided above before applying for a mortgage.

People with minimal credit history may have what is called a “thin file”. This can happen when you’ve newly immigrated to Canada or simply haven’t had the chance to build credit yet. In this situation, creditors may have a difficult time determining your “creditworthiness” and may not be able to decide whether to approve your credit application.

Getting a prepaid credit card can be a great option if you’ve got a “thin file”, as it allows you to improve your credit score and build a history of credit usage. Prepaid credit cards require you to pay a deposit upfront for the amount that you will use. For example, if your prepaid credit card limit is $3,000, you will need to deposit that money before using the prepaid card.

• Review your credit report regularly

Checking your credit score regularly is a priority. Not only will it keep you motivated to lift your score, but it will also keep you up-to-date on any unpaid balances or collections. By regularly checking your credit score, you’ll be able to monitor any inaccuracies and ensure that there aren’t any signs of identity theft or fraud on your credit file.

Now that you know how to boost your credit score and see results, let’s discuss the common pitfalls people encounter when trying to improve their credit score. Here are a list of things you’ll want to avoid if you’re looking to build or maintain a good credit score:

• Underusing credit cards

Avoiding credit cards altogether isn’t the best way to build a strong credit history. Instead, use your credit card for purchases you would buy anyway. Afterwards, mark a note in your calendar or set a phone reminder to pay off the balance by the due date. Credit cards can be an extremely useful tool for bumping up your credit score from a fair or good to an excellent one.

• Closing your oldest line of credit

Cancelling your credit card may have a negative impact on your credit score since it decreases your available credit and increases your credit utilization ratio. If you’re thinking about closing a credit card account, consider closing the newest one rather than the older one so you can maintain the longer credit history of your older card.

• Taking out too much credit

Taking out credit is not a problem in itself, particularly if you carefully monitor your credit usage. Things get tricky, however, when having access to more credit tempts you to overspend and unknowingly increase your credit utilization ratio. If having access to more credit makes you want to bump up your spending, you might benefit from setting a budget to help keep your expenses under 35% of your available credit.

• Exceeding your credit limit

Going over your credit limit could lower your credit score, because it raises your credit utilization ratio. One way to avoid this is to know your credit limit and review your credit card balances regularly. By paying off your balances as quickly as possible, you’ll prevent the credit card from reaching its limit. Plus, you may want to top your credit card with cash prior to making a large purchase. Also, if you know you will exceed your credit limit beforehand, another option is to ask the lender to increase your credit limit—even if only temporarily. Note, this would require a hard inquiry.

• Making too many hard inquiries within a short span of time

Multiple credit inquiries aren’t necessarily a bad thing—particularly if they are soft inquiries, which don’t affect your credit score. However, making too many hard inquiries in a short time frame, such as applying for a credit product or getting a new service (such as a cell phone), can weaken your credit score. While there isn’t a specific number of hard inquiries that will cause your credit score to lower, you’ll want to avoid applying for a large number of financial products at the same time or within a short interval of time.

The benefits of having a high credit score are endless. People with higher credit scores typically are more likely to get approved on financial products like credit cards and loans–and receive lower interest rates. Plus, having a great credit score also makes it easier for you to get approved on those bigger purchases, like a mortgage loan.

How does my credit score impact my ability to qualify for a mortgage?

If you’re not actively looking for a property yet and just looking to get an estimate of how much mortgage you can afford, you can start by using an affordability calculator. An affordability calculator is a helpful tool to see how large of a mortgage you can qualify for and your estimated monthly payments. Plus, it only asks for your reported income and expenses, so you don’t have to worry about any inquiries impacting your credit score.

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The information in this blog is for information purposes only and should not be used or construed as financial or investment advice. Information obtained from third parties is believed to be reliable, but no representations or warranty, expressed or implied, is made by Questrade Group of Companies, its affiliates or any other person to its accuracy.