What is a good credit rating? We make sense

#MakeItMakeSense is a series from The Star that breaks down personal finance issues to help young Canadians gain more confidence and understanding when it comes to financial literacy.

This week we spoke to Tahlia, 22, who is eager to learn more about the impact credit has on a person’s finances.

“I feel like people don’t learn enough about credit. How important is credit and why isn’t it something to bother with? »

Credit, as our money expert Jessica Moorhouse explains, is the ability to borrow money from a lender so you can access goods and services now – but pay for them at a later date, more the interests.

“As soon as you use the credit, you are indebted to that lender to repay it in full. Plus, you also have to pay interest on what you borrowed, which is the cost of accessing those funds now, but also the cost you have to pay the lender for taking the risk of lending you the money. in the first place,” she said. .

To go into more detail on how credit affects you, Moorhouse gives us his top tips for #MakeItMakeSense.

How important is credit?

Access to credit is important because it allows people to make purchases now when they may not have the necessary funds for some time in the future, says Moorhouse, adding credit gives people more options.

“For example, what if you are unemployed but eventually get hired. The only thing is you need a car to get to work. If you couldn’t save the money to make the purchase up front, you could borrow the funds to buy the car from a lender,” she said.

“Then, once you start working and earning an income, you can pay back what you borrowed in installments.”

Moorhouse also cites the example of soaring house prices, saying it’s extremely rare that anyone can buy a house with cash.

“Instead, to be able to buy a house, you have to borrow funds from a lender and pay them back over decades. Without credit, most of us could never afford to become homeowners.

What is “good credit” versus “bad credit”? »

The two credit bureaus in Canada, TransUnion and Equifax, assess consumers using their own criteria and algorithms to determine who is creditworthy or not, Moorhouse explains.

“If you have been able to prove that you are responsible with credit, always make your regular payments and eventually pay off your debts in full, then you will be considered creditworthy and rewarded with a good credit score,” she said. . noted.

On the other hand, if someone is shown to be abusing credit, such as making late payments or making no payments at all, these lenders would report those actions or inactions to the credit bureaus, which would cause them to give you a low grade, she adds.

“All of this is to say that if you have a good credit score, it means you are responsible for the credit and you have a low risk of not meeting your contractual obligation with a lender,” she said.

“If you have a bad credit score, it means you’ve been irresponsible with credit in the past and therefore may be at a higher risk of not fulfilling your end of the bargain with a lender.”

How are credit scores and reports determined?

Both credit bureaus (Equifax and TransUnion) have their own criteria and algorithms for determining who is creditworthy and who is not, Moorhouse explains.

“The details of how they rate consumers are proprietary, so we can only make estimates, but in general they use a point system where you earn points for using credit responsibly and losing credit. points if you mishandle it,” Moorhouse said.

A credit score is the rating that credit bureaus give consumers to show you and lenders the risk you’re running if they lend to you, Moorhouse says. The higher the score, the less risk you are.

According to the Financial Consumer Agency of Canada, factors that can affect your credit score include: how long you’ve had credit, whether you have a balance on your credit cards, how much you owe past due, near, equal to, or above your credit limit, and the type of credit you are using, among other things.

“When you have a high score, lenders will be more likely to offer you a low interest rate and good contract terms in order to win your business,” which is good business, Moorhouse says.

“If you have a lower score, because you are more at risk of breaking your contractual obligations with the lender, they may offer you a higher interest rate and more binding contractual conditions in order to protect themselves and the money he lends.”

A credit report is a summary of your credit history, and each time you’ve borrowed money or applied for credit, it’s reported on your credit history, she explains.

“That being said, because it is the lender who reports this information to the credit bureaus, sometimes they only report to one bureau and not both, so credit reports from both bureaus may not be the same,” she said.

Your credit history also contains information about whether you have abused or abused your credit.

“For example, it will flag things like you’ve filed for bankruptcy, had debts sent to a collection agency, or written an NSF check or have an account with insufficient funds,” she continued.

If people want to learn more about how credit scores and reports are determined, Moorhouse suggests reading books like The credit game by Richard Moxley.

What are the risks of credit cards?

Credit cards are simply tools, it’s up to you how you use them, says Moorhouse.

“If you were to use them responsibly, you would make sure to pay your balance in full each month, not spend more than 30% of your available credit limit, and never make a purchase on a credit card unless that you know you can get the funds to pay it before your bill is due.

She adds that some of the benefits of responsible credit card use are that you can earn rewards, points or cash back, and it can also improve your credit score.

“But, if you misuse your credit cards by missing payments, always carrying a balance, borrowing up to your maximum limit, or never paying off the full balance, these actions can cause your credit score to plummet,” she said.

“It could make it harder if you want to apply for credit, whether it’s another credit card, car loan or mortgage in the future.”

Additional credit advice

“When it comes to credit, the key is to have a plan,” Moorhouse said.

“It’s very easy to spend more than you can afford when you have access to credit because it seems like there’s money waiting to be used. But do yourself a favor to your future self and spend within your real financial capacity.

For some, that might mean limiting credit card use to only major purchases you’ve saved up in advance and fixed expenses like bills and subscriptions, she says.

For others, it might mean paying your credit card weekly instead of monthly to avoid accidentally missing a payment or spending more money than you actually have, says Moorhouse.

“The important thing is to remember that you are responsible for the credit and the consequences of misuse can take years to rectify.”

Learn more about Star’s #MakeItMakeSense series.

Have a question or scenario you’d like to see covered? Contact Madi by email [email protected] and we’re going to #MakeItMakeSense.

Jessica Moorhouse is a Canada® Certified Financial Advisor, host of the More Money podcast, and founder of financial education company MoorMoney Media Inc.

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