What is a good credit score? We make sense

#MakeItMakeSense is a Star series that breaks down personal finance questions to help young Canadians gain more confidence and understanding around financial literacy.

This week, we speak with Tahlia, 22, who is eager to learn more about how credit can affect a person’s finances.

“I feel like something people don’t learn enough about is credit. What is the importance of credit and why is it not something to play with?

Credit, like our money expert Jessica Moore explains, it is the ability to borrow money from a lender so that you can access goods and services now, but pay them off at a later date, plus interest.

“As soon as you use credit, you’re in debt to that lender to pay it off in full. In addition, 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,” he said. .

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

What is the importance of credit?

Having access to credit is important because it allows people to make purchases now when they may not have the funds for them until some point in the future, Moorhouse explains. Adding credit gives people more options.

“For example, what if you’re unemployed but eventually get hired. The only thing is that you need a car to go to work. If you hadn’t been able to save the cash to make the purchase up front, you could borrow the funds to buy the car from a lender,” he said.

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

Moorhouse also points to skyrocketing home prices as an example, saying it’s extremely rare for someone to be able to buy a home with cash.

“Instead, to pay for a home purchase, you have to borrow funds from a lender and pay them off over the course of decades. Without credit, most of us could never afford to become homeowners.”

What is ‘good credit’ versus ‘bad credit’?

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

“If you have been able to show that you are responsible with your credit, consistently make the required regular payments, and ultimately pay your debts in full, then you will be considered creditworthy and rewarded with a good credit rating,” he said. He said.

On the other hand, if someone is shown to be misusing credit, such as making late payments or not making any payments, then those lenders will report these actions or inactions to the credit bureaus, leading them to give you a bad credit. qualification. add.

“All of this is to say that if you have a good credit rating, it means you are responsible with credit and have a low risk of defaulting on your contractual obligation to a lender,” he said.

“If you have a poor credit rating, it means you’ve been irresponsible with credit in the past and therefore could be at greater risk of defaulting on 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 to determine 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 generally they use a points system where you earn points if you use credit responsibly and lose points if you mismanage it,” he said. Moorehouse.

A credit score is the score credit bureaus give consumers to show you and lenders how much risk you’re taking if you lend, says Moorhouse. The higher your score, the lower your risk.

According to the Consumer Financial Agency of CanadaFactors that can affect your credit score include: how long you’ve had credit, whether you have a balance on your credit cards, the amount of your outstanding debts, being near, at or above your credit limit, as well as the type of credit you are using, among other things.

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

“If you have a lower score, because you are at higher risk of defaulting on your contractual obligations to the lender, they may offer you a higher interest rate and more restrictive contract terms to protect themselves and the money they are lending. ”.

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

“That said, because it is the lender that 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 identical.” said.

Your credit history also includes information about whether you have misused or abused credit.

“For example, it will report things like filing for bankruptcy, having debts sent to a collection agency, writing a bad check, or having an insufficient funds account,” he 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, you decide how you use them, says Moorhouse.

“If you used them responsibly, you would make sure you pay your balance in full every month, spend no more than 30 percent of your available credit limit, and never make a purchase with a credit card unless you know you can get the credit. funds to pay it off before your bill is due.”

She adds that some of the benefits of using a credit card responsibly is 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 the balance in full, those actions can send your credit score plummeting,” he said. .

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

Additional Credit Tips

“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 there seems to be money waiting to be used. But do your future self a favor and spend within your real means.”

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

For others, it might mean paying off your credit card every week instead of every month to avoid accidentally missing a payment or spending more cash than you actually have, Moorhouse explains.

“The important thing to remember is that it’s up to you to be responsible with credit, and the consequences of misuse can take years to correct.”

Read more of the star #MakeItMakeSense series.

Have a question or scenario you’d like to see addressed? Contact Madi by email madisonwong@thestar.ca and #MakeItMakeSense.

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

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