When it comes to your credit report, not all debts are created equal. Lenders carefully evaluate multiple factors before approving financing, including your credit rating, payment history, outstanding balances, credit history length, new credit inquiries, and the types of credit you use. Mastering these five factors and comprehending their impact on your credit score can significantly enhance your chances of securing financing at the most favourable rates available.
If you're unsure about your current credit score, you can easily check it online for free using Equifax.
Types of Debt
Before delving into the factors affecting credit, it's essential to grasp the various types of debt and how they differ:
1. Revolving Credit: This category encompasses any credit that you can pay down and subsequently use again, such as lines of credit or credit cards. With revolving credit, you're provided with a specific borrowing limit, and as you make payments and reduce the balance, the available credit becomes accessible once more. Demonstrating diversity in your credit report by managing more than one revolving credit account, alongside installment credit, can be beneficial.
2. Installment Credit: In contrast, installment credit involves debts paid off gradually by the borrower over a predetermined period. You borrow a fixed sum of money with a fixed interest rate, and you repay it monthly until the debt is cleared. Examples of installment credit include auto loans, mortgages, and student loans. Unlike revolving credit, installment credit is a one-time borrowing opportunity; once repaid, you can't borrow from the same source again.
Factors Impacting Your Credit Score
These two types of credit are available to Canadians, but most people may not fully grasp the elements influencing the calculation of revolving and installment credit. Your credit score hinges on several factors, including the amount of debt you hold, your spending habits, the regularity of debt repayment, the presence of hard credit inquiries, and derogatory marks from collection agencies. Understanding this credit equation can provide clarity on how credit bureaus determine your credit score.
Breakdown of Credit Score Factors
1. Payment History - 35% of Your Score: Lenders prioritize payment history when evaluating financing applicants. This factor accounts for one-third of your credit score. A few late payments may not significantly impact your score, but multiple late payments can. Late payments remain on your credit report for seven years. However, prompt debt repayment can help you recover from credit delinquency quickly.
2. Credit Utilization - 30% of Your Score: Having substantial debt isn't necessarily problematic, but using a high percentage of your available credit can raise concerns for lenders. If you frequently carry high balances on multiple credit accounts, your chances of securing financing at favourable rates may diminish compared to an applicant who consistently pays off their debt each month.
3. Length of Credit History - 15% of Your Score: Creditors value experience over youth in the world of credit scoring. While you don't need to be a credit veteran, a longer credit account history is advantageous. It demonstrates your ability to manage and repay debt over time, enabling lenders to assess your risk accurately. Closed accounts can remain on your credit report for 7-10 years.
4. New Credit - 10% of Your Score: Lenders scrutinize the amount of new credit you seek. Applying for numerous new credit lines in a short period can potentially lower your credit score. It can reduce your average account age, impacting your credit history length and overall score. Lenders use this information to gauge your credit-seeking behaviour.
5. Types of Credit in Use - 10% of Your Score: Your experience with different forms of credit matters. Credit mix constitutes 10% of your overall credit score calculation. Maintaining multiple types of credit accounts responsibly can positively affect your score and demonstrate your ability to handle different forms of borrowing. Canadians with diversified credit accounts tend to have higher scores compared to those with only one type of credit. Balancing between installment and revolving credit can boost your credit score.
In conclusion, understanding these five factors and their respective weights in your credit score calculation can empower you to manage your credit more effectively. By paying attention to payment history, credit utilization, credit history length, new credit applications, and credit mix, you can make informed financial decisions and improve your overall creditworthiness over time.