Are you working on building your credit? Credit card debt in Canada soared during the final months of 2022 as many consumers turned to credit cards to keep up with the rising cost of living.
While credit cards can be incredibly useful when used the right way, misusing them can negatively impact your credit score and cost you money in the long run. The good news is that your credit score is constantly changing and can easily be improved with the right steps.
Below, I’ll explain how credit scores work, what a good (and a bad) score looks like, and offer some practical tips to help you improve your score.
Your credit score is a measure of your creditworthiness. It offers transparency to lenders, allowing them to make an informed decision based on your financial history.
With a higher score, you’re deemed a more responsible borrower and may receive more favourable loan terms, credit card offers, and more. With a lower score, you represent a greater risk to lenders, which could result in higher interest rates, less favourable loan offers, and denial of credit.
In Canada, credit scores range between 300 and 900. A good credit score is a score between 660 and 724.
Here’s a look at how your credit score reflects your creditworthiness, according to Equifax:
There are two major credit bureaus in Canada: Equifax and TransUnion. Whenever you apply for a loan or open a revolving account such as a credit card, your application and payment history are recorded by the lender and sent to both bureaus.
Sometimes, there may be small discrepancies between your Equifax and TransUnion scores, as some lenders may only update one bureau rather than both.
These two bureaus use algorithmic scoring models to determine your credit score based on the following factors.
Payment history
Your payment history accounts for 35 per cent of your credit score, which makes it the most influential factor in your score. This accounts for all of your account payments and includes late payments, on-time payments, and collections accounts that you’ve defaulted on.
One of the simplest ways to maintain a good credit score is to simply make all of your payments on time.
Available credit
Your credit usage accounts for 30 per cent of your score, making it the second-most impactful credit factor. This measures the ratio of your available credit to what you’ve used.
For example, if you have a $10,000 credit limit (a single card or spread across multiple cards), and you’ve carried a balance of $2,500 over to the next month, your credit usage would be 25%.
TransUnion and Equifax recommend that you keep your credit usage under 35 per cent to maintain a positive score.
Credit variety
Credit variety makes up about 15 per cent of your credit score and accounts for the types of credit you have, such as revolving credit (credit cards), personal loans, and auto loans. Generally speaking, the more variety you have on your credit profile, the better. Creditors want to see how you handle different types of credit. Note that opening multiple credit cards will not affect your credit variety, as it would all be considered the same type of credit.
New credit applications
New credit applications account for 10-12 per cent of your score. Pursuing too many lines of credit in a short period of time can negatively impact your score.
Credit history
The overall length of your credit history accounts for just 5-7 per cent of your score and measures the age of your oldest credit account. It’s usually a good idea to keep your old credit cards open, even if you pay them off and don’t use them anymore, as this can increase your credit profile’s age. For example, if you still have the very first credit card you ever received but don’t use it, provided you don’t have to pay fees for it, it might be good to keep it open to increase both your credit history and your available credit. Both of these factors can impact your credit score positively.
Here are four practical tips that you can start working on today to improve your credit score.
1. Develop and diversify your credit history
If you have no credit or are just starting out, you should start developing your credit history. The easiest way to do this is to apply for a secured credit card, which you’ll fund upfront.
This is similar to a reloadable debit card, but each payment will be reported to the credit bureaus, which can boost your score and eventually allow you to apply for a traditional credit card that allows you to earn cashback on your purchases.
Once you build your credit history, you can apply for other loans as necessary.
2. Pay off your credit card each month
In addition to making your minimum monthly payments on time, you should also try your best to pay your credit cards off each month, as this will reduce your credit usage. This indicates that you’re a responsible borrower who doesn’t spend more than you can afford.
3. Spread out your credit applications
When you apply for a new credit card or loan, an inquiry is reported on your credit profile and can remain there for up to two years. If there are a lot of back-to-back inquiries on your profile, it may indicate desperation, which may decrease your score and look bad to lenders.
4. Remove negative items from your credit report
Your credit report may not be 100 per cent accurate. Periodically, creditors misreport information to Equifax and TransUnion or may neglect to report positive items, such as an account paid on time.
To determine this, get your free credit report from both bureaus and try to identify any errors.
If you find any, you can send a letter to the creditor and/or credit bureau in question asking them to amend the error. Once amended, this can improve your score for the better.
How long does it take to improve your credit score?
Depending on your current score and how good or bad it is, it could take as little as a couple of months or as long as a couple of years to see significant improvements to your score.
Individuals with a younger credit history and fewer negative items may find it easier to repair their credit compared to those with a longer credit history and a long list of negative items.
Alternatively, if you’re just starting out on your credit journey, apply these principles, and you may never have to worry about fixing your score in the first place.
Christopher Liew is a CFA Charterholder and former financial advisor. He writes personal finance tips for thousands of daily Canadian readers on his Wealth Awesome website.
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