A credit score is a three-digit number that is calculated using a mathematical formula based on the information in your credit report.
- You get points for actions that demonstrate to lenders that you can use credit responsibly.
- You lose points for things that show you have difficulty managing credit.
Your credit score is not a part of your credit report. It’s a separate piece of information that is available to creditors to assess your creditworthiness. While you can get a free copy of your credit report, you must pay to get your credit score.
Each credit bureau has a different formula for calculating credit scores and they do not disclose what the formula is. There are, however, five main factors that affect your credit score:
- Payment history is the most heavily weighted factor when calculating your credit score. Paying bills on time will improve your score. Late payments, missed payments, accounts in collection and bankruptcy will reduce your credit score. These negative items are removed over time and so it is possible to improve your credit score even after filing bankruptcy or a consumer proposal.
- Credit utilization, how much you owe as a percentage of your credit limit, is the second biggest factor but is something you can take control of right away. Reducing your balances owing will have a positive impact on your credit score. Maxing out your credit cards will lower your credit score. In general, a good credit score means a utilization rate for all loans of 30% or less.
- Length of credit history affects your score because it can show that you are a reliable borrower. If you have filed bankruptcy or a consumer proposal, you will in effect be starting over and will need to show that you have been able to manage credit wisely for a while in order to improve your credit score.
- The types of credit. Credit bureaus look for a healthy mix of accounts between revolving credit (like credit cards and lines of credit) and term loans (like car loans). You can begin to rebuild your credit with something like a secured credit card. However, you will need to add other types of longer term loans to achieve a very good credit score. In addition, having too many of one type of account can also be bad. If you have a car loan and 10 credit cards, this indicates to the credit bureaus that you may be mismanaging your credit, which can drive down your credit score.
- The number of credit inquiries will also impact your credit score. When lenders ask for a copy of your credit report, it is called an inquiry. Applying for a loan is considered normal, but if you apply for several new loans or re-apply multiple times after being turned down for a loan it provides the credit bureau with a signal that you are a bad credit risk. Applying for loans, having an employer, utility company or landlord ask for your credit report are considered ‘hard’ hits or enquiries that will impact your credit score. Requesting your own credit report, or lenders seeking a copy to update their records, are considered ‘soft’ hits and do not impact your credit score.
Other factors that can have a negative impact on your credit score:
- Moving recently and / or frequently. If you are moving temporarily (say for school or work), consider using a family member’s address as a permanent address.
- Changing jobs or employers often.