Demystifying Credit Scores: Factors That Impact Your Score and How to Build Credit Score

Jun 25, 2024

A phone in front of a city background showing a 752 credit score
A phone in front of a city background showing a 752 credit score

In today's financial landscape, credit scores play a crucial role in determining your eligibility for loans, credit cards, mortgages, and even rental agreements. Understanding how credit scores work and what affects your credit score is essential for maintaining healthy financial habits and securing favourable lending terms.

In this blog post, we will dive into how credit scoring models work, the key factors that influence your credit score, and we'll provide practical tips on how to build and maintain a strong credit profile.

What Is a Credit Score?

A credit score, also known as FICO score, is a three-digit number ranging from 300 to 850 that reflects your creditworthiness. You can think of it as a form of reference that lenders will use to measure the likelihood of you paying the bills on time. Your credit score will be monitored and measured by the two credit bureaus, Equifax and Transunion. Note that you may have different credit scores between credit bureaus, as they may have a different scoring model. Credit scores also may impact the interest rate and other terms on any loan or other credit accounts.

Most negative credit history on your credit report will stay up to seven years. This means that the credit history starts to fall off after seven years from the date of your first missed payments (or any other negative items). This is the main reason why you should use your credit wisely. No one wants a bad item on their credit report when they are applying for a mortgage loan!

Understanding the Credit Score Range

Credit scores fall into different ranges, each indicating a level of creditworthiness. Knowing where you stand can give you a clearer picture of your financial health. Here are the common credit score ranges:

Poor Credit Score (300-579): Limited credit options and a higher interest rate.

Fair Credit Score (580-669): Some credit options are available, but not the best terms.

Good Credit Score (670-739): Access to better credit terms and lower interest rates.

Very Good Credit Score (740-799): Strong credit profile with favourable lending terms.

Excellent Credit Score (800-850): Top-tier credit with the best rates and terms.

Monitoring your score and working towards the higher end of your range can open doors to improved financial opportunities.

A credit score chart ranging from poor to excellent credit scores

Building Credit for Newcomers

Building credit can be a unique challenge for newcomers like international students in Canada. Limited credit history in the country can hinder your access to financial opportunities. Explore options like secured credit cards, student loans, and rent reporting to establish a credit history. Responsible credit management during your student years can set you up for a stronger financial future.

Factors That Affect Your Credit Score

Credit scores, or FICO scores, are calculated based on a variety of factors, each carrying a different weight. The specific formula for measuring your credit score is unknown, but by following the steps listed below, you will be able to reach a strong credit history, if not a higher credit score. Here are the primary factors that influence your credit score:

1. Payment History:

Your payment history is the most significant factor affecting your credit score. It tracks whether you've paid your bills on time. Late payments, defaults, and bankruptcies can all have a negative impact on your score.

2. Credit Utilization Rate:

This factor measures the credit usage rate or ratio of your credit card balances to your credit limits. High credit utilization suggests you're heavily reliant on credit, which can lower your score. Keeping your credit card balances low (below 30% of the available credit limit) is generally recommended.

3. Length of Credit History:

The length of time your credit account has been active matters. A longer credit history can positively influence your score, as it provides a more comprehensive picture of credit risk and your financial behaviour.

4. Types of Credit:

A diverse mix of credit accounts, such as credit cards from different financial institutions, mortgages, and installment loans, can demonstrate responsible financial management and slightly boost your score.

5. New Credit Inquiries:

Opening several new credit accounts within a short period can be seen as risky behaviour. Each hard inquiry for new credit can temporarily ding your score.

How to Build and Improve Your Credit Score

Building a credit history from a low credit score may sound daunting, but don't worry; we will help you. Now that you know the factors that affect your credit score let's explore how to build and improve your credit score over time. Your credit history (consisting of spending and repaying habits) will be directly reported to a credit bureau and its credit reports.

1. Pay Your Bills on Time:

Consistently paying your bills by their due dates is the single most effective way to maintain a positive payment history. Consider setting up automatic payments or reminders to help you stay on track.

2. Manage Your Credit Utilization Rate:

Aim to keep your credit card balances well below your credit limits. If possible, avoid just matching the minimum payment and try to pay off your balances in full each month to avoid accruing interest and maintain a healthy credit utilization rate. Opening up a new credit card will also lower your credit utilization ratio, but keep in mind that opening several new accounts in a short period of time will harm your credit score.

3. Open Credit Accounts Wisely:

While a mix of credit products can be beneficial, avoid opening multiple new accounts or credit mix simultaneously. Each new account generates a hard inquiry and reduces your average account age.

4. Monitor Your Credit Reports:

Regularly check your credit report for errors or fraudulent activities. You're entitled to a free annual credit report from each of the two main credit bureaus (Equifax and TransUnion). According to Equifax, checking your credit score will not have an effect on your own credit report. Requesting a copy of your credit report or checking your credit score is known as a “soft inquiry.” They are not visible to potential lenders when they view your credit report.

5. Be Cautious with New Credit:

When shopping for a loan, such as a mortgage or a car loan, do your rate shopping within a short time frame (around 14 days). Multiple inquiries for the same type of credit are often treated as a single inquiry and harm your credit rating and history.

6. Use Credit Responsibly:

Having credit is a responsibility. Use it to demonstrate your ability to manage debt rather than as a means of living beyond your means. We strongly advise you not to spend up to your available credit, as this will mean a higher credit utilization rate. Be aware of your available credit and spend accordingly!

Conclusion

Your credit score is a dynamic indicator of your financial health, impacting your ability to borrow money, access credit, and secure favourable terms. By understanding the factors that influence your credit score and adopting responsible financial habits, you can steadily build and maintain a good credit score. Remember, building a good credit score takes time and consistent effort, but the benefits are well worth it in the long run.

Get started with Chexy today to start building credit and earning rewards on your rent payments.

Subscribe to The Chexy Rundown for exclusive access to travel deals, credit card rewards, and more ways to build your credit score.

Commonly Asked Questions

Q1: What is a good credit score?

Good credit scores typically fall within the range of 670 to 739. Higher credit scores are even better, as they can qualify you for lower interest rates and better lending terms.

Q2: How often does my credit score update?

Credit scores are not updated in real-time. They typically update when new information is reported to the credit bureau, which can be monthly for some accounts. It's a good practice to check your credit score regularly, but don't expect daily fluctuations.

Q3: Will checking my own credit score hurt my credit score?

No, checking your own credit score online is considered a soft inquiry and does not affect credit scores. There are no direct negative impacts with too many credit checks. Credit bureaus, credit card companies, and financial institutions will let you check your free credit report online. However, when a lender checks your credit as part of a loan application (a hard inquiry), it can have a minor negative impact on your score.

Q4: Can I improve my credit score quickly?

It usually takes time to significantly improve your credit score. Timely payments, responsible credit utilization, and long credit history are factors that develop gradually. Be cautious of any services promising rapid credit repair; improving your score is a steady process.

Q5: Should I close old credit card accounts?

Closing old credit accounts can potentially lower your credit score. A longer credit history is favourable, so if you have old accounts with positive payment histories, it's often better to keep them open. Also, note that multiple credit card accounts will result in a higher credit limit.

Q6: Can I negotiate negative items on my credit report?

You can dispute inaccurate or outdated information on your credit report. If the negative item is accurate, it will remain on your report for a certain period (e.g., late payments for up to seven years). It's better to focus on building positive credit habits.

Q7: How long does it take to rebuild credit after a bankruptcy?

Bankruptcy has a significant impact on credit scores, but its effect lessens over time. A Chapter 7 bankruptcy remains on your credit report for 10 years, while Chapter 13 remains for 7 years. However, you can start rebuilding credit immediately by responsibly managing new credit accounts.

Q8: Can I build credit scores without a credit card?

Yes, you can build credit scores with installment loans (e.g., a personal loan or auto loan), but credit cards are often more accessible and can be used to demonstrate responsible credit management. With Chexy, you can start building your credit score by reporting rent payments.

In today's financial landscape, credit scores play a crucial role in determining your eligibility for loans, credit cards, mortgages, and even rental agreements. Understanding how credit scores work and what affects your credit score is essential for maintaining healthy financial habits and securing favourable lending terms.

In this blog post, we will dive into how credit scoring models work, the key factors that influence your credit score, and we'll provide practical tips on how to build and maintain a strong credit profile.

What Is a Credit Score?

A credit score, also known as FICO score, is a three-digit number ranging from 300 to 850 that reflects your creditworthiness. You can think of it as a form of reference that lenders will use to measure the likelihood of you paying the bills on time. Your credit score will be monitored and measured by the two credit bureaus, Equifax and Transunion. Note that you may have different credit scores between credit bureaus, as they may have a different scoring model. Credit scores also may impact the interest rate and other terms on any loan or other credit accounts.

Most negative credit history on your credit report will stay up to seven years. This means that the credit history starts to fall off after seven years from the date of your first missed payments (or any other negative items). This is the main reason why you should use your credit wisely. No one wants a bad item on their credit report when they are applying for a mortgage loan!

Understanding the Credit Score Range

Credit scores fall into different ranges, each indicating a level of creditworthiness. Knowing where you stand can give you a clearer picture of your financial health. Here are the common credit score ranges:

Poor Credit Score (300-579): Limited credit options and a higher interest rate.

Fair Credit Score (580-669): Some credit options are available, but not the best terms.

Good Credit Score (670-739): Access to better credit terms and lower interest rates.

Very Good Credit Score (740-799): Strong credit profile with favourable lending terms.

Excellent Credit Score (800-850): Top-tier credit with the best rates and terms.

Monitoring your score and working towards the higher end of your range can open doors to improved financial opportunities.

A credit score chart ranging from poor to excellent credit scores

Building Credit for Newcomers

Building credit can be a unique challenge for newcomers like international students in Canada. Limited credit history in the country can hinder your access to financial opportunities. Explore options like secured credit cards, student loans, and rent reporting to establish a credit history. Responsible credit management during your student years can set you up for a stronger financial future.

Factors That Affect Your Credit Score

Credit scores, or FICO scores, are calculated based on a variety of factors, each carrying a different weight. The specific formula for measuring your credit score is unknown, but by following the steps listed below, you will be able to reach a strong credit history, if not a higher credit score. Here are the primary factors that influence your credit score:

1. Payment History:

Your payment history is the most significant factor affecting your credit score. It tracks whether you've paid your bills on time. Late payments, defaults, and bankruptcies can all have a negative impact on your score.

2. Credit Utilization Rate:

This factor measures the credit usage rate or ratio of your credit card balances to your credit limits. High credit utilization suggests you're heavily reliant on credit, which can lower your score. Keeping your credit card balances low (below 30% of the available credit limit) is generally recommended.

3. Length of Credit History:

The length of time your credit account has been active matters. A longer credit history can positively influence your score, as it provides a more comprehensive picture of credit risk and your financial behaviour.

4. Types of Credit:

A diverse mix of credit accounts, such as credit cards from different financial institutions, mortgages, and installment loans, can demonstrate responsible financial management and slightly boost your score.

5. New Credit Inquiries:

Opening several new credit accounts within a short period can be seen as risky behaviour. Each hard inquiry for new credit can temporarily ding your score.

How to Build and Improve Your Credit Score

Building a credit history from a low credit score may sound daunting, but don't worry; we will help you. Now that you know the factors that affect your credit score let's explore how to build and improve your credit score over time. Your credit history (consisting of spending and repaying habits) will be directly reported to a credit bureau and its credit reports.

1. Pay Your Bills on Time:

Consistently paying your bills by their due dates is the single most effective way to maintain a positive payment history. Consider setting up automatic payments or reminders to help you stay on track.

2. Manage Your Credit Utilization Rate:

Aim to keep your credit card balances well below your credit limits. If possible, avoid just matching the minimum payment and try to pay off your balances in full each month to avoid accruing interest and maintain a healthy credit utilization rate. Opening up a new credit card will also lower your credit utilization ratio, but keep in mind that opening several new accounts in a short period of time will harm your credit score.

3. Open Credit Accounts Wisely:

While a mix of credit products can be beneficial, avoid opening multiple new accounts or credit mix simultaneously. Each new account generates a hard inquiry and reduces your average account age.

4. Monitor Your Credit Reports:

Regularly check your credit report for errors or fraudulent activities. You're entitled to a free annual credit report from each of the two main credit bureaus (Equifax and TransUnion). According to Equifax, checking your credit score will not have an effect on your own credit report. Requesting a copy of your credit report or checking your credit score is known as a “soft inquiry.” They are not visible to potential lenders when they view your credit report.

5. Be Cautious with New Credit:

When shopping for a loan, such as a mortgage or a car loan, do your rate shopping within a short time frame (around 14 days). Multiple inquiries for the same type of credit are often treated as a single inquiry and harm your credit rating and history.

6. Use Credit Responsibly:

Having credit is a responsibility. Use it to demonstrate your ability to manage debt rather than as a means of living beyond your means. We strongly advise you not to spend up to your available credit, as this will mean a higher credit utilization rate. Be aware of your available credit and spend accordingly!

Conclusion

Your credit score is a dynamic indicator of your financial health, impacting your ability to borrow money, access credit, and secure favourable terms. By understanding the factors that influence your credit score and adopting responsible financial habits, you can steadily build and maintain a good credit score. Remember, building a good credit score takes time and consistent effort, but the benefits are well worth it in the long run.

Get started with Chexy today to start building credit and earning rewards on your rent payments.

Subscribe to The Chexy Rundown for exclusive access to travel deals, credit card rewards, and more ways to build your credit score.

Commonly Asked Questions

Q1: What is a good credit score?

Good credit scores typically fall within the range of 670 to 739. Higher credit scores are even better, as they can qualify you for lower interest rates and better lending terms.

Q2: How often does my credit score update?

Credit scores are not updated in real-time. They typically update when new information is reported to the credit bureau, which can be monthly for some accounts. It's a good practice to check your credit score regularly, but don't expect daily fluctuations.

Q3: Will checking my own credit score hurt my credit score?

No, checking your own credit score online is considered a soft inquiry and does not affect credit scores. There are no direct negative impacts with too many credit checks. Credit bureaus, credit card companies, and financial institutions will let you check your free credit report online. However, when a lender checks your credit as part of a loan application (a hard inquiry), it can have a minor negative impact on your score.

Q4: Can I improve my credit score quickly?

It usually takes time to significantly improve your credit score. Timely payments, responsible credit utilization, and long credit history are factors that develop gradually. Be cautious of any services promising rapid credit repair; improving your score is a steady process.

Q5: Should I close old credit card accounts?

Closing old credit accounts can potentially lower your credit score. A longer credit history is favourable, so if you have old accounts with positive payment histories, it's often better to keep them open. Also, note that multiple credit card accounts will result in a higher credit limit.

Q6: Can I negotiate negative items on my credit report?

You can dispute inaccurate or outdated information on your credit report. If the negative item is accurate, it will remain on your report for a certain period (e.g., late payments for up to seven years). It's better to focus on building positive credit habits.

Q7: How long does it take to rebuild credit after a bankruptcy?

Bankruptcy has a significant impact on credit scores, but its effect lessens over time. A Chapter 7 bankruptcy remains on your credit report for 10 years, while Chapter 13 remains for 7 years. However, you can start rebuilding credit immediately by responsibly managing new credit accounts.

Q8: Can I build credit scores without a credit card?

Yes, you can build credit scores with installment loans (e.g., a personal loan or auto loan), but credit cards are often more accessible and can be used to demonstrate responsible credit management. With Chexy, you can start building your credit score by reporting rent payments.