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The Score- Understanding Credit Ratings

October 30, 2012

The Score – Understanding Credit Ratings

Your credit rating is one of the most important, yet least understood aspects of your financial life. It determines whether or not you can borrow, whether you can get a credit card, what kinds of interest rates you will be paying, and even in some cases, whether you can rent a home. You even need a credit card to get a hotel room, rent a car, or pay for parking in some places. Yet it still remains a mystery, especially to young adults, who end up learning about it the hard way when it is too late.  Most people have a foggy understanding of it, but few of us really know how it works, when we really should.

Most of the time, people establish credit when they are in their late teens or early twenties, by having a parent co-sign on a utility bill or loan, or alternatively by obtaining a secured credit card. The creditors will then report this to a credit bureau (Equifax or Trans Union). From this point  forward, your payment behavior will be tracked, and updated. The bureau also records  important information about you on the credit report, such as your current,  former, and second former addresses, your name and former names, credit inquiries, employment history, public records and other info regarding bankruptcy, collections, and judgements, and creditor info on your borrowing history. There is also important info from your creditors such as: opening date, date last reported, credit limit, payment terms, balance, past due amount, rating, amount of times delinquent on payments, and how late, previous delinquencies and dates of, and last date of activity.

The most common term we hear in respects to credit rating is your “beacon score” this is a number, or “score” compiled by the bureau and based on the different  factors to be taken into consideration.  They break it down something like this:

  • Payment History (Previous credit performance) -  35%
  • Credit Utilization (Current level of indebtedness)  - 30%
  • Credit Inquiries (Need for new credit) - 10%
  • Types of Credit In Use (Types available) – 10%
  • Credit History (Amount of time credit has been in use) – 15%

As you can see from this, your track record of making required payments on time, and how much of your available credit that you are using, are the 2 biggest factors involved in how the credit bureau scores you. Making your payments on time, and keeping your credit card balances below 75% of the available amount is the best way to avoid trouble in these aspects.

If you have made late payments, then there are factors which determine the amount deducted from your beacon score. How much time has passed since the last missed payment, how many missed payments, and how badly missed that they were. For example, a couple of weeks missed on a credit card payment will have a lower impact, than going to collections will.

The credit bureau will divide each of your debts by the credit limit determine your current  level of indebtedness. Keeping your balances low on all credit cards and lines of credit is the best way to keep this part of your scoring good.

But let’s not forget the other areas that affect your beacon score. If possible, avoid applying for too many loans or credit cards, especially if you are denied by another lender. Each credit check that you have done affects your score. The exception to this rule, is with Mortgage (via mortgage brokers) and Auto loan applications(via dealerships). In these cases, you are given a buffer to apply multiple times with no effect to your score: all similar inquiries within a 14 day period are totaled and counted as one inquiry 30 days later. It is important to note that bank inquiries are not treated this way as the bureau cannot tell what type of application it is, and so each inquiry is counted separately.

The types of credit you have will also have an effect.  The two main types of credit are “installment” (eg. car loans, mortgages) and “revolving” (eg. credit cards etc. where you can pay them down, but still have the credit available to you). The quality of a credit card is higher than a department store card for revolving, since it is more difficult to obtain one. The same goes for a mortgage for installment since the qualification rules are the most stringent.

Lastly, the length of time that you have had the credit counts for 15% of the scoring. This is because, the longer you have had it, the more likely that you have gone through a layoff or illness or other life events that would affect your ability to pay. It shows a proven track record to more accurately assess your likelihood of paying on time.

I am hoping that this simple information will help you to understand and improve your own credit ratings and solve the mystery around it. I should stress that it is a record of your borrowing and repayment behaviors, and not a record of how much money you have. Someone who works at McDonald’s could have a better credit rating than a highly paid professional, and even pay lower interest rates, because they have been better at making payments on time.

Courtesy of,

Rodger Lajeunesse
Mortgage Professional
The Mortgage Centre Comox Valley

Questions? Call one of our Mortgage Professionals today! (250) 898-8821 or toll free 1-866-898-8821

 


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