How Your Credit Score is Calculated
Every month, each of your creditors sends a report card to the credit bureau, grading your level of responsibility as a borrower. The combination of these reports from each creditor over a period of time paint a picture of your credit worthiness that potential future lenders can use to make a decision about whether or not to lend you money when you need it.
Credit scores are generated by plugging the data from your credit report into software that analyzes it and cranks out a number. The two major Canadian credit reporting agencies don’t necessarily use the same scoring software, so don’t be surprised if you discover that the credit scores they generate for you are different.
There are 5 broad categories the system looks at to compute your score. Here is a simple explanation of each and a breakdown of the weighted importance placed on each category.
- Your payment history - Pretty self explanatory…either you pay on time or you don’t. 35% of your score is dependant on your payment history and each time you are more than 30 days late or worse counts! Always make your payments on time, and if you must pay something late make sure it’s 29 days late or less.
- What you owe - The system likes to see that you are a balanced, responsible credit user. This means that being maxed out on every account is bad which is obvious, but it also means that having 10 accounts with a zero balance is bad too (contrary to popular belief). Not using credit is not indicative of a responsible borrower, it’s like you never borrowed anything at all which gives no indication to the bureau of what kind of borrower you are. The ideal number is to be carrying between 10-30% of your available credit (loans, lines of credit, credit cards) with consistent activity over a period of time.
- Length of your credit history - Just like anything else, the longer you have a good, clean, measurable record the better. Remember, this means a long record of activity, not inactivity. 15% of your score is dependant on the length of your history.
- Types of Credit - Remember, balance is important! The system will score you higher if you have a good mix of different borrowing vehicles (lines of credit, loans, credit cards) rather than 6 credit cards alone. It is also important to note that the bureau does not like retail credit cards (the ones that charge 30% interest!) because their easy to get and even easier to default on! Be careful with those “Don’t pay a cent events”
- New credit – There is a point where credit shopping begins to look suspicious. That’s why the bureau tracks your application patterns. Every time you apply for credit, an “inquiry” appears on your bureau. Too many inquiries in a short period of time will work against you in two ways. It will make the next potential creditor ask themselves “why is everyone else declining this person?” and it will eventually bring your score down. Just another good reason to use a broker (one application) when arranging a mortgage right?
Update: There’s more information on how your credit effects your mortgage application under Getting Approved.
Wonderful topic to explain the mysteries that surround BEACON scores.
Plain, Simple, Easy to understand terminology.
Thank you
David Pylyp
Thanks for your feedback David.
I should also point out that you can check your own credit as many times as you like in a year without effecting your credit score. You should do this periodically to make sure everything is in order.
Pro-actively checking your own credit score will alert you to any attempted identity theft too. More on that another time!
Here’s a link to one provider, TransUnion.