How is your credit score calculated and why is it important? –

You know credit scores exist. You might even know what yours is. But do you know how it’s calculated and why it matters?

Your credit score determines whether you can get a credit card, rent an apartment, buy a house, start a business, or even get a cell phone contract.

A low credit score can limit your choice of loans or whether you can get one – and if you can, it could have a high interest rate.

“There’s a huge cost to having a low credit score that happens to people, a real financial cost to them, and it’s a shame that people don’t learn that or know that or don’t lend to it. watch out until it’s usually too late,” said Colleen McCreary, consumer finance advocate at Credit Karma.

Here’s an overview of how you can create healthy habits to avoid having a low credit score:

What is a credit score?

A credit score is a mathematical formula that helps lenders determine how likely you are to repay a loan. Credit scores are based on your credit history and range from 300 to 850.

“It’s a score that’s going to determine how comfortable people are with lending you money,” McCreary said.

If your credit score is high, you can borrow more money. But if it’s low, you can borrow less or no money, or borrow money with a high interest rate, which can then create more debt.

Banks, landlords, and insurance companies look at your credit score to determine the type of credit card you can get approved for, if you’re the right fit for an apartment, and your insurance rate, among other things. .

“Essentially, the bank will say, ‘Hey, you don’t have a good credit rating. Instead of 2% interest, we’re going to give you 3% interest,’” he said. Kristin Myers, editor. from The Balance, a personal finance website. “That could mean you’re paying more money over the life of a loan each month.”

How is my credit score calculated?

Although the idea of ​​credit scores is simple, how they are determined is more complicated.

Credit scores can come from several credit reporting agencies. You can access your credit report online for free from Equifax and TransUnion. Everyone has their own model for calculating credit scores.

Although we generally know what factors go into credit scores, agencies do not share their specific formulas with the public. But each produces a slightly different score.

“One scores like a basketball game, one scores like a football game, and one scores like a hockey game,” said McCreary, who added that you shouldn’t worry if an agency gives you some points less than the others.

Since you don’t know which agency your lender will go to to check your credit score, McCreary also recommends that you check all three before applying for major credit.

Here are the factors frequently used to calculate your credit score:

  • Bill payment history
  • Length of credit history
  • Current outstanding debt
  • How much of your available credit you are using
  • New credit applications
  • If you’ve had a debt sent to collection, foreclosure or bankruptcy

One thing that doesn’t affect your credit score is how much money you earn, McCreary said. But you should always be careful to only borrow the amount you can afford to repay.

Other aspects that don’t affect your credit score include your age, location, and demographic information such as race, ethnicity, and gender, according to Experian.

How can I find out my credit score for free?

There are several ways to check your credit score for free. A good place to start is to check if your bank offers this service to its customers. Additionally, each of the credit reporting agencies allows you to check your credit score for free.

What is a good credit rating?

You are considered to have a good credit score if it is 670 or higher. If your credit score is above 750, you’re considered to have an excellent credit score, McCreary said.

“There’s this kind of dream scenario of having a credit score over 800, it’s a very high credit score and very few people ever get there,” McCreary said.

“Fair” credit scores are considered to be between 580 and 669, a credit score below 580 is considered bad credit.

Six tips to improve your credit score

The journey to improving your credit score is different for everyone. But some steps that can help you fight credit card debt include paying at least the minimum monthly payment and, if you can, paying a little more than the minimum in order to pay less. interest over time.

1: Know your starting point

The first step to raising your credit score is knowing your current score and what’s showing up on your credit report, said Kristin Myers, editor of The Balance, a personal finance website.

“You can’t fix what you don’t know,” she said. “Check if there are any errors or if you have already made a dispute and it is still showing up.”

Once you see what’s in your report, you can begin to identify where you might have weaknesses. For example, if you have a large debt on one of your credit cards, start paying off that debt to reduce credit usage that affects your credit score.

2: Manage your debts as much as you can

Ideally, you pay off your credit card every month. But, if that’s not possible for you, making small payments can help you maintain or increase your credit score.

If you can, pay a little more than the minimum monthly payment so you pay less interest over time.

A well-known method of payment is the “debt snowball” where you pay off your debts from smallest to largest, to build momentum and good habits. Once the small debts are paid off and you get into the habit of paying off your debts, the money you used to put aside each month can then be used for larger debts.

3: Avoid more debt, if you can

Not taking on new debt is another way to boost your credit score, Myers said. If you haven’t repaid the debt you currently have, it’s best not to open any other lines of credit. If you are in a situation where you rely on credit due to economic circumstances, try to avoid unnecessary purchases which could significantly increase your debt load.

4: Use credit cards, but in moderation

Many people’s first instinct is not to use a credit card to avoid getting into debt. However, this is not a good tactic if you want to have a good credit rating. It’s best to have at least one credit card, but the key is to use it in moderation, said Colleen McCreary, consumer finance advocate at Credit Karma.

“You don’t want to use more than 30% of the credit that’s available to you, but you want to use those cards even a little to prove that you can be trusted,” she said.

When you use your credit card, be sure to pay on time each month and try to use it only for purchases you already intended to make and can afford.

5: Don’t close your old accounts

After paying off your credit card, you might think it best to close the account to avoid using it again.

It actually hurts your credit score. Since one of the factors in your credit score is the length of your credit history, if you close your oldest credit card account, you also erase it from your credit history.

“Keeping the length of that credit history open is extremely important because the length of time you’ve had a loan or line of credit is going to raise your credit score,” Myers said.

6: If you don’t have a credit history, start safe

If you’re just starting out and want to grow your credit, there are several ways to secure this process so you don’t get into debt. One of the most recommended ways is to open a “secured card”, which are credit cards that require a deposit that is usually equal to the amount of credit given to you.

The deposit is there in case you can’t repay the credit, but it’s returned to you after you switch to an “unsecured” card. Secured cards are reported to the credit bureaus, which means that this line of credit appears on your credit file and can help you build or fix your credit score.

The Government of Canada also provides resources on how to improve your credit score.

Does checking my credit score lower it?

Checking your credit score doesn’t lower it unless you do a “thorough investigation,” which is only done when applying for a line of credit.

Informal inquiries, where you want to know your credit score, do not affect your score and it is good practice to check your credit score often to ensure it is accurate.

On the other hand, lenders make tough inquiries when you apply for credit, such as a mortgage or car loan, and these appear on your credit report.

McCreary recommends not applying for multiple credits at the same time as this could hurt your credit score. It’s best to know your credit score ahead of time and then apply when you’re sure your loan will be approved.

How can I create healthy habits with my credit score?

The first step is to check in at least once a year to make sure you’re comfortable with your current credit score.

If you’re considering applying for a large line of credit, you want to check your score a few months in advance and see how you can start improving it. If you’re currently trying to boost your credit score, it’s a good idea to check it often to see if your actions are making a difference.

If you notice an error in your credit report, you can dispute it by contacting the respective credit reporting agencies.

Knowing your credit score and maintaining healthy habits in this regard is essential to having a good credit history. However, it’s important for people to know that their financial worth shouldn’t be tied to their credit score, Myers said.

“It doesn’t mean you’re a bad person or you struggle with money and constantly have to fight,” she said.