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One of the most important reasons to use your credit card responsibly is to build your credit rating and demonstrate your worth to financial institutions. Your credit rating is a number between 300 and 900 that tells lenders (financial institutions) the risk of lending you money; the higher the rating, the lower the risk. Now let’s look at how your credit score is calculated, what is considered a good credit score, why is it important, and how you might be able to increase it.
How is your credit score calculated?
First of all, credit is a way to make purchases without physically having the money in your wallet – with the promise, of course, that you will repay your creditor (the institution that gives you the loan) within a prescribed. You find credit, for example, in the form of credit cards, mortgages, student loans, etc. How you use your credit over time will determine your credit rating.
The following five points are taken into consideration when calculating your credit score
- Your payment history for all your accounts (this comes into play if you’ve been late paying any of your bills)
- The balance of your credit compared to its limit
- The number of years you’ve been building your credit
- The recent number of applications for additional credit
- The type of credit you currently have (loans, credit cards, etc.)
The two personal credit reporting agencies in Canada – Equifax, and TransUnion – do not reveal exactly how the credit score is calculated, but this pie chart published by FICO1 concretely represents the weight of each of the criteria.
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As you can see, making the minimum payments (if not more) on time is one of the most important things you can do to build good credit. The balance of your accounts relative to the maximum credit allocated to you is the second most important factor to consider.
The number of years you’ve been building your credit is another piece of information that credit reporting agencies look at when determining your credit score. For example, you will have a better credit score with a card that you have held and paid for 5 years than with a card that you have held for only a few months.
The number of times you have applied for new credit, including how many times your credit report has been checked – are indicators that you may be having trouble borrowing money or trying to borrow more than you can pay.
Finally, it is more advantageous to have several types of credit, for example, a credit card, a personal loan, or a mortgage loan, compared to a single type. This will tell lenders that you can handle multiple forms of credit.
What is a good credit rating?
All of the information mentioned above will then be converted into a 3-digit number between 300 and 900 – as mentioned above, the higher the rating, the better. A perfect rating is 900 but if it ends up above 750 it is considered excellent. You will need to have a score of around 680 to be able to access the best interest rates regardless of the type of credit you wish to obtain, including mortgages and personal loans.
If your rating is below 680, this does not necessarily mean that creditors will not lend you money; it simply means that you will get higher interest rates as you represent a higher risk – higher risk means higher premiums. For example, if your credit score is below 600, you won’t be able to get a mortgage from a major bank, private lender, or reputable company. Instead, you will receive an adverse credit mortgage (which includes higher interest rates) from a bank, private lender, or trust company.
Why do you need a good credit rating?
When credit scoring was introduced, it was to help financial institutions make a large volume of complex customer value decisions 1 . Therefore, it has always been a headache to determine the interest rate that the borrower can get when applying for a mortgage or other loans.
Today, the rating can be used in many other circumstances including when you want to rent an apartment, obtain an insurance policy, and even a new cell phone contract. Some people even have to authorize a credit check on their name as part of a hiring process.
In short, the credit score is made to prove one thing: how you manage your finances. For this reason, you must build and maintain a good credit rating as long as you use credit, as most people do.
How to increase your credit rating?
If you’ve missed payments, let an account go to collection, or even declared bankruptcy, your credit score will be less than optimal. To increase it, here are some steps you may want to consider.
- First, find your credit score and determine if anything on your credit report is inaccurate. If anything appears to be wrong, you should report the error to both credit reporting agencies immediately. Note: Your score is not included in free credit reports. You will have to pay to get it.
- If your credit score is so low that you are unable to be approved for a credit card, consider putting money into a prepaid credit card to start rebuilding your credit.
- Pay all your bills (all forms of credit) on time. Even if your regular bills aren’t used to build your credit, some cell phone companies may report late payments.
- Try to pay all of your bills or at least the minimum payment.
- Never go over your credit card limit. Also, remember to try to keep your balance below 35% of your limit.
Over time, all of these steps will help you build your credit history which will eventually lead to a good credit score.
