Have you ever wondered how a credit score is calculated? And why does a credit score matter so much when applying for new credit? You may or may have thought about it. But no matter the reason, the credit score does play an important role while applying for a new line of credit.
Canada has one of the highest financially literate people in the whole world. With over 61% financially literate people. But just by being financially literate doesn’t guarantee that you won’t make a bad financial decision. It is natural and happens to many people.
Sometimes, a bad financial decision can severely affect the credit score and results in a lower credit score. For example, even though you had a genuine reason, your creditors are concerned, leading to a poor credit score. Moreover, it can take up to 18 months or more to improve your credit score.
In the meantime, if you encounter a difficult time, getting a loan can be difficult. Even if you find a lender ready to provide you with a loan, they’ll charge a higher interest rate on the amount. So, bad credit can lead to a lot of problems.
But, of course, you can apply with an online loan lender with an online loan application in Canada. In this article, we’ll have a deeper look at credit score and how it is calculated in Canada.
What is a credit score?
A credit score or FICO score is a three-digit number that is assigned to individuals who have an active credit history. These numbers range from 300 to 750 or 800. The higher your score is, the better your chances of getting a good loan.
The credit scoring system is a unified system that impartially assigns a credit score to people. This system was created to make a unified way to check the creditworthiness of a person. However, it showed many flaws and problems over time, but it is still used worldwide to assess a borrower’s credibility.
How is credit score calculated?
There are three major credit bureaus in Canada – Equifax, Transunion and Experian- that records every person’s credit and manage their credit history. Majorly they see the following five factors while giving a credit score to a person.
- Payment history
- Payment history is the most important of all. It makes up 35% of your total credit score. This accounts for all the late payments, timely payments and defaults. So, if you make timely payments, you will have a good credit score. It is as simple as that.
- But what will happen if you have a bad payment history? The opposite! If you fail to make the payment on time, you will have 30 days time period to pay that amount.
- If you couldn’t pay in that time, your creditor will inform the credit bureau, which will be recorded in your credit history, which will affect your credit score and cause it to fall.
- In the case of default, you will straight away lose 250 points. And that will be a significant drop in your credit score.
- So, to keep your credit score in good shape, ensure you pay on time, don’t delay any repayments and obviously do not default on payments.
- Credit usage
- The second most important part of your credit score is credit usage, which accounts for 30% of your overall credit score.
- This includes the number of accounts you have, how much credit you have used and how much you owe.
- If you have a higher credit usage in multiple accounts, your score will lose points, whereas only spending small parts of credit will improve your credit score over time.
- Similarly, if you have applied for new credit, it may temporarily lower your credit score, but if you continuously pay on time and reach the end of your credit duration, it will increase because you will have created a good payment history for that loan.
- Credit history
- After the payment history and credit usage, the third most important factor is credit history. The longer you have a credit history of timely payments, the better your credit score. This is why it is advised to keep your credit line open.
- If a lender opens your credit file and has no credit history to check, it would greatly affect your credit score. If you are beginning to build your credit history, it will take nearly 18 months to build a decent credit history.
- So ensure you are making timely payments, build a good credit history, and avoid any defaults on payments. Moreover, a default can take up to 6 years to disappear from your credit history. So, you should try avoiding getting one.
- Types of credit
- The next is the type of credit line you own. Having multiple credit lines will help you build a great credit history and, over time, will result in a great credit score.
- Different credit lines include credit cards, home loans, car loans, personal loans or any other type of loan. These loans have different loan applications in Canada, which you can apply through a bank or other financial institution.
- Once you get a new credit line, ensure you make timely payments and use them effectively to keep them active and continuously build credit history.
- Hard and soft inquiries
- Finally, hard and soft inquiries account for 10% of your credit score. These entries are done to check your credit score and credit history.
- Soft inquiries are all those inquiries that you make. These entries are not recorded in your credit history. Soft inquiries are inquiries made by you. For example, checking your credit score.
- On the other hand, a hard inquiry is recorded on your credit history. A hard inquiry can often lead to a slight drop in your credit score, which is fixed over time with timely payments.
- A hard inquiry occurs when you apply for a new credit line, such as a home loan or credit card. The institution you are applying with makes a hard entry to check your credit history and analyze your credibility.
A credit score can be a detrimental factor in getting a loan. However, sometimes, with a bad credit score, you can get a loan but at a higher interest rate. So, you can also apply with online loan lenders, such as PrestoCash, to apply for an online loan. In addition, our online loan application in Canada helps you receive loans while you are on your way to improving your credit history.