Let's Talk: Credit

You may already be familiar with credit since you may have credit cards or you own a home. This week, I'll break credit down and explain what to look for and how to monitor your credit.

What is Credit?

Credit is essentially a system to determine how trustworthy you are when you borrow money. It's used by lenders, landlords and even certain employers to assess how much of a risk you are to them. Credit enables you to do a variety of things you normally wouldn't be able to because of a lack of funds. You can make large purchases like a house or car without paying the entire amount upfront. Credit would allow you to still make the purchase but you have to agree to pay it back over a period of time. It's a very useful feature to use since the majority of the population aren't millionaires.

You can see why it plays such an important role in a person's life. Without credit, you may be denied rent, jobs and different types of loans. You would be forced to pay for everything in cash. The idea of it sounds great but isn't very realistic. If more people were forced to only use cash, fewer people would be able to own homes, cars, go to post-secondary and invest because they simply wouldn't be able to afford it. The largest hurdle would be the cost. How many years would they have to work and save for an average house of $300,000 before they can buy their home? Many would probably become homeowners just as they retire or they might forgo the idea altogether.

Credit Report

In Canada, Equifax and TransUnion are the two official companies that monitor and report our credit. If you've ever opened any type of credit account then you have your own personal credit report. If you never had any type of credit account before then you don't have a credit report. Each company uses their own model to measure you through a credit score. The credit scores for Equifax and TransUnion, respectively, ranges from 300-850 and 300-900. Having a higher score is better because you would be seen as a trustworthy client. You would be eligible for exclusive offers and receive the lowest rates possible when borrowing. If you have a higher number within a range, it doesn't necessarily mean you'll be treated any better. All you get are bragging rights. Someone at 800 will receive the same offer as someone with a score of 900. The numbers may vary because each company uses a different scoring model but the ranges are typically ranked:

• 781-900 - Excellent: You're a unicorn and lenders will compete for your business
• 661-780 - Very Good: You've done a great job. More credit products will become available to you.
• 601-660 - Fair: Students and people starting to build their credit fall in this range.
• 300-600 - Poor: Lenders will avoid you. If you are accepted, the limit is very low and requires collateral.

Other information included on your credit report:

• Personal Information - Name, address, SIN, date of birth
• Hard Inquiries - A pull on your application by lenders or when you apply for a new credit product. This will decrease your score.
• Soft Inquiries - A pull on your application that won't affect your credit score.
• Public Records - Includes your bankruptcies, lawsuits, liens, etc. These stay on your report for 7 years.
• Consumer Statements - You can add information regarding your activities
• Trade Lines/Credit Ratings - History of your activities

Types of Credits

You can check out this link to learn more as well as see samples of reports from both Equifax and TransUnion. All your credit accounts will be separated and assigned a rating into the following categories:

• Revolving (R) - credit cards, line of credits (LOC), home equity line of credits (HELOC)
• Installment (I) - student loans, car loans, and personal loans
• Open (O) - post-paid cell phones 
• Mortgage (M)

Credit Maintenance

How do you increase or maintain your credit score? Well, all you have to do is pay your loans and debts on time. Sounds easy enough, right? There are actually a few other factors that affect how your credit score is calculated. Being able to balance all of these factors will help you achieve a great score. 

• Payment History (35%) - Paying your bills on time play the largest factor in affecting your credit score
• Amount Owed (30%) - Keep your credit utilization less than 30% of your available credit limit to boost your score. This means spending near or your entire limit is unhealthy for your credit!
• Length of Credit History (15%) - A longer history of on-time payments will help. A good history is about 6 months or more of consistent payments
• Types of Credit (10%) - Having numerous types of credit will help boost your score 
• New Credit (10%) - Applying for lots of new credit in a short period of time will decrease your score

5 C's of Credit

Through responsible spending and paying of your credit, your report will begin to display attributes that lenders look for when they decide to approve future applications. These are the 5 attributes will be the deciding factor:

• Character - Lenders like people who are responsible because it shows that they can be trusted when they give out loans
• Capacity - This is your ability to repay your loans. For some applications, lenders will ask how much you make to see if you have the ability to repay
• Capital - How much have you personally invested? This shows lenders that you're serious about getting credit
• Condition - Lenders look at all factors including you and the economy to determine whether giving you credit is appropriate for them
• Collateral - This is only required if lenders don't trust that you can repay them

Some Tips

Did you know that it's free to check your credit report once a year with Equifax and TransUnion. You should make it a habit to check your report for errors and fraud. Mistakes do happen and they negatively affect your score. It's actually up to you to find these errors. Checking it more often than that would require a fee.

Alternatively there are free credit reporting services like CreditKarma, Borrowell and MOGO. I can understand if you feel uncomfortable using 3rd party services but they are legitimate services that allow you to monitor your credit score for free. If you are, you can stick to the official companies but are limited to checking your report once a year for free. CreditKarma grabs your report from TransUnion. MOGO and Borrowell uses your report from Equifax. Your score may vary slightly but it's a great way to monitor your scores for free.