What Affects Your Credit Score – and How to Fix It

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When searching for a new apartment, buying a home, leasing a car, or applying for a credit card, most businesses will run a credit check on you. To obtain the best rates and approvals, it’s important that your credit report and score are in good shape. If you’ve recently been denied on an application, your credit could be the reason!

What Affects Your Score

There are 5 major categories of things that affect your score, to varying degrees:

1.       Payment history: Accounting for 35% of your score, payment history is the most important factor to consider. Ideally, always pay on time. Missing payments negatively impacts your score, and each time you miss a payment the effect is worse.

2.       Credit utilization: Another 30% of your score depends on credit utilization, or more simply, what percentage of your credit is in use (owing) at a given time. If you have one credit card with a limit of $2,000, and are carrying a balance of $1,000, you are using 50% of your available credit. If, however, you have two credit cards with limits of $2,000 and a $500 balance on each, you are now only using 25% of your available credit. Lower is better.

3.       History: 15% of your score is attributed to history, meaning the longer you have credit (with good behaviour, like on-time payments) the better your rating will be. If you have no credit, you can’t demonstrate to a lender that you are able to handle it, so you may be denied or receive higher rates.

4.       Credit type: Certain kinds of credit are more reputable than others, and this accounts for 10% of your rating. A low-interest mortgage or secured line of credit has a much higher weight than a 29% interest store credit card, for example.

5.       Inquiries: Applying for credit at multiple institutions in a short time frame can be a signal that someone is “desperate” for credit. Since it’s also a sign that you might be shopping around (e.g. for the best interest rate), the credit bureau counts any checks within a two week period for the same kind of credit as one inquiry, and this won’t affect your score. Try to avoid applying for an apartment, a loan, a car lease, multiple credit cards, and a new cell phone in a short time period though.

How to Fix It

The first step in improving your credit rating is to get your credit report. In Canada, you can get a free report from Equifax or TransUnion (or both) showing everything that affects your credit. For a small fee, you can also get your actual score.

·         Look for errors in your report – even an incorrectly reported balance or limit can make a difference – and apply to have them corrected. Experts have estimated that as many as 25% of credit reports contain errors drastic enough to affect your score.

·         Pay bills on time, every time from now on. Showing you’ve changed your ways is important as it diminishes the effect of past missed payments. Even if you can’t pay in full, always make at least the minimum payment by the due date.

·         Pay off and consolidate unattractive debt (like high-interest cards) as quickly as possible. Even if you need a line of credit or equity loan to pay these off, that debt will look better on your credit report.

·         Don’t close old accounts as it reduces the amount of credit available to you (your utilization). Instead, make a small purchase every 4-6 months on old cards, and pay it off right away, to keep your accounts from getting stagnant.

·         Don’t reduce your credit limits if you can help it. For some people, having available credit is a temptation to spend – they should cancel cards and focus on changing behaviour. If you can handle a higher limit though, keep it available so your utilization percentage is lower. Never exceed your credit limit; try to stay under 30%.

·         Deal with collections and outstanding accounts. If you’ve paid off an old debt, get something in writing saying the account was paid in full and closed.

It will take time to improve your credit – many infractions will remain on the report for six years – but if you make a conscious effort to demonstrate responsible use of credit, you should notice a difference within a few months.