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Credit Score: The Truth Behind It and Why It’s Important

Are you planning to borrow money for a major purchase such as a home or car in the not too distant future? Before lenders extend you credit, they want to make sure you’re going to pay it back in full and on time. How do they do that? They do it by reviewing your credit score.

Your credit score is one of the key factors lenders consider before approving your credit application. By maintaining a good credit score, you’re more likely to get favourable loan terms, which can help you save money.

In this article I’ll put a positive spin on credit scores and share some of the truths behind it and why it’s so important.

What is a Credit Score?

A credit score is a three-digit number assigned to you by the credit bureaus, Equifax and TransUnion. Just like your grades in school, the higher your credit score, the better it is. Your credit score is a number that falls between 300 (lowest) and 900 (best). You don’t have to have a perfect credit score. A score of at least 680 is considered good by most lenders and can help you get the lowest interest rate.

Now that you have a better understanding about credit scores, let’s take a look at the five key factors that impact your credit score.

Your Payment History

Lenders are looking for borrowers who have a steady payment history. In fact, your payment history is the most important factor to lenders. To be seen in a positive light by lenders, try to pay your bills on time and in full. Sometimes life happens and you can’t afford to pay the full amount. If that happens, at least make the minimum payment so that your credit account remains in good standing.

Your Available Credit

The second most important factor after your payment history is your available credit. Your available credit is how much money you can borrow at any given time. You can figure out your available credit by taking your credit limit minus any balances that you’re carrying on your credit credits. Aim to use less than 35 percent of your available credit. If you use any more than that, it can negatively impact your credit score.

The Number of Credit Inquiries

Credit inquiries are when lenders make a request to obtain information on your credit. There are two kinds: soft hits and hard hits. Soft hits, such as requesting your own credit report, don’t count towards your credit score, while hard hits, such as applying for a credit card or mortgage, do. Try to limit the number of credit facilities you apply for, otherwise it could lower your credit score.

Your Credit History Length

Lenders also want to see that you have a long track record of using credit in a responsible manner. They care about how long you’ve had credit accounts open. So, if you’re thinking about cutting up a credit card you haven’t used for a while, you might think twice, since it could actually lower your credit score. (Just be sure to use it every once in a while to avoid those pesky inactivity charges.)

Credit Types

Lenders prefer a mix of credit. If you just have one type of credit, it can actually lower your score. Instead of just having credit cards, try to spice it up with credit cards, lines of credit and personal loans. But don’t go crazy. Only apply for credit that you truly need.

About the Author

Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Finance Journalist, Money Coach and Speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense. Connect with Sean on LinkedInTwitterFacebook and Instagram.