Demystifying Credit Scores
September 7 2023 Posted by John C Filice
These days, like so many things, your credit score is easily accessible and free. Not so long ago, the only way to see your credit score was to obtain a copy of your credit report, which involved submitting a request and paying for the privilege. In 2014, however, legislation was passed that transformed the credit reporting landscape and Canadian consumers now enjoy the convenience of instant access to their credit score. While it can be an incredibly useful tool to give you a general idea of your financial standing and to protect yourself against identity theft or fraud, it's important to understand that your free credit score (often referred to as a "consumer credit score" or "educational credit score") isn't what lenders use to make lending decisions.
In Canada, there are two credit bureaus – Equifax and TransUnion – that collect information from various sources (banks, lending institutions, government agencies, landlords, utility companies, telecom companies, etc.) to build your credit file. Your file contains a lot of detail about you such as employment history, payment history, outstanding debts, credit inquiries, plus any public records pertaining to finances. The credit bureaus use various complex scoring models to interpret the data and assign you a 3-digit credit score ranging from the lowest (300) to the highest (900). The higher the score, the better.
While most people think their credit score and their credit report are the same thing, they are not. Think of your credit report as your financial report card and your credit score as your overall grade. Your credit score does carry some weight with lenders, but it's just a starting point. To determine what kind of risk you are likely to be as a borrower, they must delve a little deeper into your file to get the complete picture.
Here are some of the key areas that lenders take into consideration:
- Payment History: It's simple but extremely important. Do you consistently pay your bills on time? This is a key behaviour that lenders are looking for and one of the strongest predictors that you are likely to meet your financial obligations in future. It is generally the most heavily weighted factor in most credit scoring models.
- Credit Utilization: Creditors and lenders look favourably on someone who isn't maxing out their available credit. Even if you're not missing payments, keeping your accounts near their maximum limit can be interpreted by lenders as a sign that you're not able to manage your spending.
- Credit Mix: It's generally preferred by lenders to have a diverse mix of credit in your file. For example, someone with a credit card, loan and mortgage might be viewed more positively than someone with three credit cards.
- Recent Credit Inquiries: If lenders see that you've opened or applied for multiple credit accounts recently, they might be concerned as this may suggest an increased borrowing risk. One of the advantages of working with a mortgage broker is that we can submit your mortgage application to multiple lenders with only one credit inquiry.
- Credit History: Lenders look at your credit history to understand your financial behaviour over time. A well-documented history of responsible credit behaviour is usually a very good indication that you will be able to manage debt in future.
- Public Records and Collections: Bankruptcies, liens, judgments, and accounts in collections are red flags for lenders as they indicate potential financial difficulties.
So while that free credit score you got likely included some basic information such as current balances, recent credit inquiries, any missed payments, etc., it's nowhere near the amount of detail that lenders see when they pull your credit bureau. As your mortgage broker, I possess extensive knowledge and experience in the mortgage industry. We can review your credit together in a stress-free environment to provide a comprehensive understanding of your creditworthiness from a mortgage lender's perspective, help you gain valuable insights into how lenders perceive your financial profile and help you understand your mortgage eligibility. I can also provide guidance on improving your creditworthiness, if necessary. If your mortgage renewal date is approaching, if you're contemplating a move or if you'd just like a mortgage review, please feel free to get in touch so we can have a conversation. I'm always available.