5 steps to improving your credit score – Part 2

by Karen

Now that you know what is in your credit history and how to get one, let’s take a look at what is a good credit score? And how the score is being calculated? If you have tried looking on Equifax and TransUnion website, you know that they provide VERY little information about the actual formula. These guys don’t give away much because they want to protect their little secret and their proprietary information.

In general, there are five factors that determine your credit score. This is based on FICO (Fair Isaac Corporation) score model. FICO is a global standard that most banks use for measuring credit risk in the banking, mortgage, credit card, auto and retail industries for the last 25 years. In short, these are the factors that will determine your credit score.

  1. Payment history.

Payment history account for 35% of your score. This one is the biggie so please pay attention to it. Skipping payments or late debt payment can negatively impact your credit score BIG time. Paying your bills on time, every time is a key way to help improve and even rebuild your credit score. It is important that your bill on time even just the minimum amount!

If you have public records, these can remain on your credit report up to 7 years or more. Public record refers to bankruptcies, judgments, and collection records. They are sure ways to do lasting damages to your credit score. American lenders are typically more forgiving about bankruptcy records, the Canadians are not. Bankruptcy is a really bad stain on a Canadian consumer credit record. Not just lending requests, Canadian banks also request your credit record when you want to open bank account. I witnessed customers being turned down for account open request because they had bankruptcy record.

The other sin is not paying big brother (aka: your government). If you owe government money in tax, student loan, or other government debts, they will also report the delinquent payments or non-payment on your credit history. And it is really bad news for you when they do. I lost count how many times I told young customers: “your student debt is money you owe the government. So if you don’t pay, they will put your delinquent student debt record in your credit report.  And yes, you may not be qualified for loan request if you have delinquencies.” Don’t mess with the government debt.

  1. Current debt.

The other biggie is your current debts which account for 30% of your score. If you have high balances relative to your total credit limit (i.e: utilization of available credit), this could indicate a greater risk of default and bring your score down. Yes, banks give you credit, but they don’t want you to max them out all the time either. My rule of thumb is not to draw the balance to 100% of my authorized credit limit because it will impact my score and I will have to pay a lot of interest. So, I use 1 credit card only and I pay off the balance on due date. See my post on debt consolidation. This is my sure way to make the most use of the credit card perks, save on interest payment and sustain good credit score.

  1. Length of credit history.

Accounts for 15% of your credit score is the length of your credit history. The longer credit history is better because it can demonstrate the consistency in your repayment behavior. Just to be clear! It isn’t just impacted by how long you’ve had access to credit. You need to have good trends in payment patterns and credit applications. While having a long history of good credit can boost your credit score, a habit of missing payments or applying for new credit can nose dive your score to bottom.

  1. New accounts

New credit account represents 10% of your score. Opening multiple new credit facilities in a short period of time may negatively impact your score because this could imply that you are actively seeking credit. On the flip side, a stable record with occasionally new credit account and decent repayment history will be a big plus for you.

  1. Types of credit

 Lastly, the types of credit you have, will take the last 10%. Having a mix of credit products in your portfolio such as: a mortgage, loan, line of credit and one or two credit cards is more favorable than having multiple credit cards. Striking the right balance between types of credit can improve your credit score significantly.

Keep in mind, these are the big 5 used in FICO scoring model, Equifax, TranUnion and Experian have their own model. I studied all of them.  There are differences but they are not substantial and I don’t want to bore you with all the “nerd appeal” details. Seriously, you will not be able to stay awake if I describe all these models in details. I read them because, well…I like these stuffs. Yes, you can laugh. These stuffs are fun and interesting to me. In a nutshell, if you can maintain the big 5 that I mentioned above, your credit score will be in a good shape and increase your chance of getting your loan request approve.

Other stuffs that can mess with your credit score

Now, there are other minor factors that can really mess up your credit score and you should be aware about them. They are also within your control to change and manage.

 1 – Top of the bucket is error. 

Credit reporting agencies are doing their best but they can make mistake in reporting. They are human after all. One of the major causes of point loss to your credit rating can errors that the agencies falsely report about you.  Back in 2012, the CBC report on credit reporting mistakes that seriously impacted a number of Canadians.

I was “almost” a victim of reporting error when I applied for my mortgage. There was someone who lived in Vancouver whom had the exact same name as mine but she had different date of birth and address. Somehow, my lender ended up getting this “fake” Karen’s credit report. My lender was shocked when he saw a score of 530 on the credit report because he knew me for years. To make the long story short, he got my “real” credit report at the end and I was approved. I won’t tell you my score though. It is a secret. Shush!

Credit reporting is done electronically, and Credit Bureaus accept the information they are sent without any investigation into the accuracy of the information.  So it is important that you validate with your lender the information on your credit report to ensure there is no error.  If there is any inaccurate information, contact the credit reporting agency and ask them to correct the information. Once you report the error, then it is up to the credit reporting agencies to investigate your complaint, validate the information and make the correction. This is your right as a consumer, so exercise it.

Now, just because you report the error, it doesn’t automatically mean that the agency will correct it. So it is always a good idea to follow up with them 60 days after you report the error. It can be a lengthy and time consuming process to correct error on your credit report, but this has financial consequence to you, thus I encourage you to invest your time to correct it.

2 – Too many credit checks

Try not to have too many inquiries on your credit report at one time because it can be interpreted as credit seeking activities. In short, your lender may believe that you are actively borrowing from multiples lender and thus reduce your chance of getting credit.

3 – Having no debt is also not good for you. 

When you have too much debt, it is bad for you. But having no debt is also not good news for our credit score. I know, we can’t win at all. So try if you must to see this from the banks/lender’s stand point.  Imagine, someone just tell you they are good borrower but there is no record to prove it, would you believe them? Likely not, right? The banks are the same. If you have no debt, then there is no history for the agency to determine your credit repayment behaviour.  So, the point is to have some credits and use them responsibly to show your good borrowing character. Don’t go overboard like my card collector friend. Like everything else in life, balance is the key.

Now the answer you have being waiting for: why 650 score? According to TransUnion, 650 is the magic middle number – a score above 650 will likely qualify you for a standard loan while a score under 650 will likely bring difficulty in receiving new credit.

Typically, most banks build credit score into their automated consumer lending model. 650 is a good score, but there are many other factors that banks look at to determine whether you are a worthy borrower. Factors such as: can you afford this loan, your income stability, networth level and how long have you been their customers. I promise that I will write a post on how bank assess you as a borrower and what you can do to increase your chance of getting your loan approve. So much to share and I can only type so fast.

How to raise or rebuild your credit score

Let’s get to the good news stuff because you must be exhausted from hearing all the bad news by now. So let me cheer you up with a light at the end of a very dark and frustrating credit history tunnel. Your credit score can be improved and repaired. Credit rating is a snapshot in time and not a stain you will have to live with for the rest of your life. Your credit rating is like your self-esteem, sometimes in your life it will be high and sometimes it will be low, however, you can always rebuild it. It will take time, patience and effort but it is worth it. There are couple of things you can do to rebuild your credit rating/score.

  1. Check up!

Make sure that the information on your credit history is correct. In my experience, a simple check with the credit reporting agency and correct their errors can instantly change your score. Remember that credit score repair or building begins with your credit report and the correct one. And your credit report is built by mere mortal and capable of making mistakes, so make sure they don’t mess up yours. It is a good habit to request a free copy of your credit report and check it for errors once a year.

  1. Remind me!

As I mentioned, repayment history is one of the biggie so pay attention to this. If you don’t remember your credit repayment due dates (I don’t either, shush!), then make sure you set up reminders in your Google calendar or whatever method that will give you a quick tap on your head that it is the time to pay your dues.

Some Canadian and US banks offer payment reminders through their online banking portals that can send you an email or text message reminding you when a payment is due, so make use of it. For your line of credit, consider set up a minimum automatic monthly payment. Even if you have more cash to pay off the line of credit, it is a good idea to have the automatic minimum set up so when you forget (which happen to all of us. Me included) your credit score will not be impact. You still should pay off as much debt as possible though. You know I will nag about this.

  1. Consolidation.

I love this C world. My sister thinks I am traumatized after spending quite a few years as a lender and a credit risk professional. True be told, I am a bit traumatized because I saw how much harm debt could do to someone’s life. The financial stress can manifest into health issues and relationship with family and loved ones. So, I try my best to educate my friends and family on this subject and hope that I can help to prevent people from making these mistakes or re-build their lives. If you have a lot of debts and it is getting out of control, consider consolidating all your debts into 1 big loan and pay it DOWN! Keep 1 credit card but cut the others. Read my post on debt consolidation and get going on this because the longer you delay the worst it will get.

4 – My last “tip” to having a good credit rating and a high credit score is to continually use credit and to repay that credit on time all the time.

Advises and solutions for the credit score terminal cases

Yes, I am taking to folks who committed the deadly sins of having public records such as bankruptcies, judgments, and collection records. These are the deadly sins of credit history but there are ways you can rebuild and make a comeback.  Now, it will not be easy but I believe that you can overcome them.

A consignor or guarantor to the rescue! So this is your story: you were a bad boy or girl who filed for bankruptcy. I am not judging you because we all have rough patches in life. The most important thing is you recognize the error in judgement and don’t repeat them. You learn your lesson and now want to apply for a credit card or loan to demonstrate that you are now on the straight and narrow path. Alas! none of the banks or alternative lenders would lend you a penny because you have a bankruptcy record.

See the dilemma? You need to borrow again and rebuild your credit record, but no one would lend you. Life is so hard sometime.  But there is a solution.  Do you have someone in your life who has financial strength and willing to provide guarantee for your credit card or loan? This is the time to ask mom, dad, uncle, aunt or a really good friend who can lend you a helping hand. Having a consignor or guarantor can be really helpful when your credit history is in a bad shape. The banks and lenders will likely lend to you if you have one. Lastly, your consignor or guarantor will likely have a lender that they have relationship with. It will increase your chance of approval even more if you apply for loan with the lender who already has relationship with your consignor or guarantor.

Pay your debt! I know, I know. You probably shaking your head now: “Karen, if I have the money I would pay. Thanks a lot smartass.”  As difficult as it is, I would press you to find way to pay your government debts, collection and judgement. Work it out with these creditors whether they are the big boss brother, an ex (child support is the most common judgment record that I came across) or a company. If you really can’t deal with them directly (but I hope you give it an honest try), I encourage you to work with a licensed debt consolidation agency. Be sure to do your research on the agency because there are quite a few unethical agencies out there.

One last common misconception, credit scores can be quickly increased! Credit scores are based on your credit history and can generally only be changed over time unless there are errors reported on your credit history record.  Be careful of those claims make by the debts consolidation that they can increase your credit score instantly. It can’t be done instantly. These claims are mostly false. I am not even certain if some of their tactics are legal.

Yes, you can re-build your credit score but it will take time and effort.  And it is also true that lender can still see your previous bad repayment history, but if you can demonstrate that your repayment behavior is improved and you are now on the “straight and narrow” path, you will likely get your loan request approve. We all make mistakes, but if you can demonstrate that you learn the lesson, people will give you a chance.

Credit history is important for your finance and wealth. After thousands of words later, I am sure you know the reasons. Take it from an ex-banker, maintain your credit score and you should be rewarded with likelihood of getting your debt request approve, renting a place that you like, passing the security check for your new job, and getting utilities services for your home. As always, I wish you find the balance to have a blissful and happy life. Credit is an important part of your wealth which contributes directly to your balanced and blissful life, so pay attention and take care of it.

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