What’s a good credit score? We make it make sense

#MakeItMakeSense is a series from the Star that breaks down personal finance questions to help young Canadians gain more confidence and understanding around financial literacy.

This week, we spoke to 22-year-old Tahlia, who is eager to learn more about how credit can impact a person’s finances.

“I feel like something people don’t learn enough about is credit. What is the importance of credit and why is it not something to mess around with?”

Credit, as our money expert Jessica Moore explains, is the ability to borrow money from a lender so you can access goods and services now — but pay for them at a later date, plus interest.

“As soon as you use credit, you are indebted to that lender to pay it back in full. In addition, you also must pay interest on what you’ve borrowed, which is the cost of accessing those funds now but also the cost you must pay the lender for taking the risk of lending you the money in the first place,” she said .

To get into more detail about how credit affects you, Moorhouse gives her best tips to #MakeItMakeSense.

What is the importance of credit?

Having access to credit is important because it allows people to make purchases now when they may not have the funds for them until sometime in the future, Moorhouse explains, adding credit gives people more options.

“For example, what if you’re unemployed but finally get hired. The only thing is you need a car to commute to work. If you hadn’t been able to save up the cash to make the purchase in advance, you could borrow the funds to buy the car from a lender,” she said.

“Then, once you start working and earning an income, you could pay back what you borrowed in facilities.”

Moorhouse also points to skyrocketing housing prices as an example, saying it’s extremely uncommon for anyone to be able to buy a house with cash.

“Instead, in order to afford buying a home, you have to borrow funds from a lender and pay it off over the course of decades. Without credit, most of us would never be able to afford to become homeowners.”

What is ‘good credit’ versus ‘bad credit?’

The two credit bureaus in Canada, TransUnion and Equifax, rate consumers using their own criteria and algorithms to determine who is creditworthy or not, Moorhouse explains.

“If you’ve been able to provide that you are responsible with credit, always make your requirement regular payments, and eventually pay off your debts in full, then you would be considered creditworthy and would be rewarded with a good credit rating,” she said.

On the other hand, if someone is shown to misuse credit, such as making late payments or not making any payments at all, then those lenders would report these actions or inactions to the credit bureaus, leading them to give you a bad rating, she adds.

“This is all to say that if you have a good credit rating, it means you are responsible with credit and you are at a low risk of not meeting your contractual obligation with a lender,” she said.

“If you have a bad credit rating, it means you’ve been irresponsible with credit in the past and thus could be at a higher risk of not fulfilling your end of the bargain with a lender.”

How are credit scores and reports determined?

Both credit bureaus (Equifax and TransUnion) have their own criteria and algorithms to determine who is creditworthy and who isn’t, explains Moorhouse.

“The specifics of how they rate consumers is proprietary so we can only make estimates, but in general they use a point system in which you gain points if you use credit responsibly and lose points if you mismanage it,” said Moorhouse.

A credit score is the rating the credit bureaus give consumers to show you and lenders how much of a risk you are if they lend to you, says Moorhouse. The higher the score, the less of a risk you are.

According to the Financial Consumer Agency of Canadafactors that may affect your credit score include: how long you’ve had credit, if you carry a balance on your credit cards, the amount of your outstanding debts, being close to, at or above your credit limit, as well as the type of credit you’re using, among other things.

“When you have a high score, lenders will be more likely to offer you a low interest rate and good contract terms in order to win over your business,” which is a deal, Moorhouse says.

“If you have a lower score, because you are at higher risk to break you contractual obligations with the lender, they may offer you a higher interest rate and more constricting contract terms in order to protect themselves and the money they are lending.”

A credit report is a summary of your credit history, and every time you’ve borrowed money or applied for credit, it’s reported on your credit history, she explains.

“That being said, because it’s the lender that reports this information to the credit bureaus, sometimes they only report to one bureau and not both so you credit reports with both bureaus may not be identical,” she said.

Your credit history also has information listed if you’ve misused or abused credit.

“For example, it will report things like you’ve filed for bankruptcy, have had debts sent to a collections agency, or have written a bad check or have an account with insufficient funds,” she continued.

If people want to learn more about how credit scores and reports are determined, Moorhouse suggests reading books like The Credit Game by Richard Moxley.

What are the risks of credit cards?

Credit cards are simply tools, it’s up to you how you use them, says Moorhouse.

“If you were to use them responsibly, you would make sure to pay your full balance off in full every month, do not spend more than 30 per cent of your available credit limit, and never put a purchase on a credit card unless you know you you can get the funds to pay it off before your bill is due.”

She adds some of the benefits of using a credit card responsibly is you can earn rewards, points, or cashback, and it can also improve your credit score.

“But, if you misuse your credit cards by missing payments, always carrying a balance, borrowing to your maximum limit, or never paying off the full balance, those actions can cause your credit score to plummet,” she said.

“This could make it difficult if you wish to apply for credit, be it another credit card, car loan or mortgage in the future.”

Additional tips on credit

“When it comes to credit, the key thing is to have a plan,” said Moorhouse.

“It’s very easy to spend more than you can afford when you have access to credit because it looks like there’s money just sitting there waiting to be used. But do your future self a favor and spend within your current affordability.”

For some, this could mean limiting credit card use to only big ticket purchases you’ve saved up for in advance and fixed expenses like bills and subscriptions, she says.

For others, it could mean paying off your credit card every week instead of every month to avoid accidentally missing a payment or spending more cash than you actually have, Moorhouse explains.

“The important thing is to remember is that it’s up to you to be responsible with credit and the consequences for misusing it can take years to rectify.”

Read more of the Star’s #MakeItMakeSense series.

Got a question or scenario that you’d like to see tackled? Reach out to Madi via email [email protected] and we’ll #MakeItMakeSense.

Jessica Moorhouse is an Accredited Financial Counselor Canada®, host of the More Money Podcast and founder of financial education company MoorMoney Media Inc.


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