Credit is a difficult thing to understand. Most people have the basic concept that they either have good credit or bad credit. What most people don’t know is what makes their credit good or bad. To the banks, credit is a measure of the probability of a loan defaulting should it be approved.
There are two credit reporting agencies in Canada. Both measure a person’s likey hood of fulfilling their credit obligations based on a complex algorithm to compute an overall score.
This calculation involves certain factors such as defaulted accounts, late payments on accounts, length of credit history, total debt load, percentage of balances versus limits, collection activity, foreclosures, judgements, bankruptcies, consumer proposals, and several other factors.
The score that they generate will range anywhere from 300 to 900. The higher the score, the more likely a person is to fulfill their credit obligations.
Credit scores are the complex end result calculation of your overall credit worthiness. They were created in the efforts of giving a simplified numerical overall risk score for someone to decide whether or not to grant a credit approval. Credit scores are affected by credit utilization (how much you have owing versus what the limit is), number of trade lines, length on trade lines, missed payments, collections, foreclosures, bankruptcies, consumer proposals, and number of inquires to your credit file.
It is important to note that while all inquires to your credit file will be posted, multiple inquiries for the same type of credit product will affect the score exactly the same as one inquiry for that product. For instance, if you were looking for an auto loan and three lenders looked at your application, it would be the same effect on score as if only one lender had looked at your application. However, if you applied for an auto loan and then went and applied for a credit card, this would affect your score twice.
While most of the time, credit score gives a good indication of the overall credit worthiness, it does however have certain flaws and draw backs. Because score is heavily dependant on factors such as credit utilization , it sometimes does give a wrong overall picture of credit worth. For instance, someone with only one trade line on bureau with a $500 limit and a $100 balance may have a much higher score than someone with multiple trade lines all paid well for a long time but fairly high on the balances versus the limits.
The credit score may indicate that it is safer to give the first person a big loan versus the other person who has well maintained all credit but has a high ratio of balances versus limits. Some lenders derive most of their decisions based on this score, while most banks have another calculation they perform which involves this score but adjusts it to suit their allowable credit tolerances. It is important to note that some banks do not even use the credit score in their credit adjudication decisions.
Curious about your score? Apply now and a member of our finance team will review your credit and overall score with you for free.
