Why your credit score matters and how you can improve it (2024)

Credit scores are like knee joints: you don’t realize just how important they are until you’ve damaged them. Unlike a knee, however, it is possible to make your credit as good as new without too much pain.

Before we dive into the deep end of the credit info pool, here are some basics. An individual’s credit score is based upon data contained in their credit report, which is essentially a summary of how they manage their financial obligations.

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Equifax Inc. and TransUnion LLC are the two credit reporting agencies that compile the data provided by Canadian lending institutions into the credit report. The report contains detailed information about a person’s credit history over the preceding six to seven years, such as who they have borrowed from, how much they owe, whether payments have been made on time and if an account is delinquent.

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Consumers can access their credit report by requesting it directly from Equifax or TransUnion, and, unlike some think, checking once a year does not negatively impact your overall score. Indeed, everyone should annually check their credit to ensure all debts owing belong to them and that they have not been a victim of fraud or identity theft.

Lenders are permitted to review a borrower’s credit report, with permission, as part of the credit application process to determine credit worthiness. Creditors are also allowed to access the contact records contained in the credit report to track down consumers who have outstanding debts. Often, employers and rental agencies will do a credit check as part of their acceptance procedures as well.

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The credit score is a number derived from past credit repayment history. It can vary between 300 and 900. The higher the number, the more likely it is that a consumer will repay the debt they are applying for. More specifically, the credit score is based on five key factors, in order of importance: payment history; total amount owing; length of credit history; credit applications; and, types of credit owing.

Each of these factors carries a different weight in determining the credit score. A person’s payment history often determines how they will handle future obligations. The report will show on-time payments as an I1 or R1, depending on whether the account being repaid is an instalment (loan) or revolving (credit card or line of credit) product.

Late payments will cause the ratings to slide down to an I2/R2 if within a month late, I3/R3 if two months late and so on. If a delinquent debt is sent to collections, it is reported as an R9/I9.

No lender will extend credit until debts in collections are dealt with. This is why the payment history has such a large impact and accounts for 35 per cent of the overall credit score. If you want to improve your credit score, be sure to make your credit payments on time each and every month.

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The total amount of debt owing counts for another 30 per cent of a person’s credit score. Lenders use this to calculate a borrower’s total debt servicing, which determines how much debt a person can afford based on their income. Optimally, no more than 40 per cent of a person’s gross income should be going towards debt payments and that includes mortgages and car payments.

Consumers should also aim to keep their average credit usage below 60 per cent of what’s available or they could bring down their credit score. For example, if you have a credit card limit of $1,000 and constantly charge up to the limit, that is an indication of risky credit management, which negatively impacts your credit score and makes the banks more leery of lending to you.

It’s best to try to keep the maximum usage each month on that $1,000 card to $600 or less. If you find you are struggling to pay the debt off in full each month, it’s time to track your spending to ensure you are not spending more than you earn. Spending less will help keep those credit-card balances down so that your overall credit score can improve.

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Someone new to borrowing in Canada, whether an immigrant or young adult, may have difficulty getting credit since they don’t have a credit history, or an established credit score, to prove their ability to repay responsibly. The length of time a consumer has had credit factors into 15 per cent of their credit score.

A person’s credit history only goes back six or seven years. Any debts older than that, with a few legal exceptions, are then purged from the credit report. This means a bad credit repayment history doesn’t have to haunt you forever, but it can impact your ability to borrow for those six or seven years if not properly dealt with.

Cleaning up collection items and having expired credit removed from your credit report will dramatically improve your credit score.

The number of new credit applications over a given time period accounts for 10 per cent of the credit score. Creditors are more reluctant to lend to a consumer who has a history of often applying for and acquiring new credit. The more credit a person has, the more likely they could have issues repaying their debts in the future.

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Often, several credit applications over a short period of time indicate deeper financial issues that the consumer may be attempting to resolve by getting more credit. Rather than taking on more debt than can be affordably repaid, reach out to a local not-for-profit credit counselling company for free advice on how to clean up your finances and get help with money management.

The remaining 10 per cent of your credit score can be influenced by the type of credit being used. Deferred payment plans can imply a consumer did not have the savings or ability to pay for what was purchased. Consolidation loans could be a sign someone is taking on more debt than can be managed. Borrowing from high-risk/high-interest lenders is also an indication of underlying financial struggles.

Even though this counts for only a small percentage of the overall credit score, having higher interest credit, deferring payments and consolidating debts can have a domino effect on the other more significant factors that can negatively impact credit scores.

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If a borrower wants to improve their credit score, the first step is to stop using credit and start tracking your spending. Next, make a budget to include all necessities, debt repayment and savings, and then what’s left over can go towards fun. Too much discretionary spending can mean having to use credit to supplement your lifestyle. Continually using credit because you can’t delay gratification can result in over-borrowing and your credit score gets damaged as a result.

If there’s just no way to fit everything you want into your budget, then it’s time to explore ways to increase your income to ensure you can afford to have the lifestyle you want.

Sandra Fry is a Winnipeg-based credit counsellor at Credit Counselling Society, a non-profit organization that has helped Canadians manage debt for almost 25 years.

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