October 17 is National Get Smart About Your Credit Day and there is no better time with the year end and holidays approaching, to sit down and review your finances. Whether you have debt or not, take this opportunity to evaluate how you manage your credit and where there could be room for improvement.
- Your Credit Score
- Credit Cards
- Help to Manage Your Debt
Your Credit Score
Credit scores reflect your current and historical financials. Lenders use them to determine how much credit they extend to you. They may even use your credit profile for something as simple as purchasing a cellphone plan. That’s why it’s important to start off on the right foot.
In Canada, credit scores are tallied using the FICO (Fair Isaac Credit Organization) formula. While FICO uses proprietary algorithms which can change at any time at their discretion, to calculate your score, it is mainly comprised of five components. Each component totals a different percentage of the final assessment.
The FICO score can be broken down like this:
- 35 percent is based on payment history (accounts are paid on time)
- 30 percent accounts for credit utilization (the amount owed vs. the available credit)
- 15 percent is for length of credit history (how long you’ve had credit, not debt)
- 10 percent is your credit mix (credit card, installment loans, etc.)
- 10 percent is based on new credit (search and acquisition of new credit and inquiries)
FICO scores can fall within these ranges:
- Poor: 300 to 579
- Fair: 580 to 669
- Good: 670 to 739
- Very good: 740 to 799
- Excellent: 800 to 850
How well do you know your credit score?
According to a national survey conducted by Rates.ca, just 60 percent of Canadians are familiar with their credit score. With younger Canadians, aged 18 to 24, the most unfamiliar (33 percent).
Experts recommend checking your credit score and report annually. This can help catch mistakes on your report and even identity theft. It can also help you keep track of credit products that may have been forgotten about like a store credit card. But most importantly, being aware of your credit score can help you improve it!
How do you improve your credit score?
How well you utilize your credit, the length of time you’ve had an open account, and how well you manage your payments will be significant factors for maintaining good credit. Paying close attention to your bills and credit accounts can help you regulate and improve your credit score.
Paying your bills:
- Always pay your bills on time
- Never miss a payment even when disputing charges
- Make at least the minimum payment every month
- Under special circumstances (illness or job loss) speak with your lender about holding payments
- Hold a variety of credit types (credit cards, line of credit, etc.)
- Only apply for credit when you need it
- Keep your balances low (below 30 percent of credit limit)
- Think twice before closing credit accounts in good standing
Repeatedly missing payments and maxing out your credit cards will have the reverse effect and leave a lasting impression on your FICO score. This information can stay anywhere from 7 to 10 years on your credit report.
We recommend you start building a credit history sooner rather than later, so that when it’s time to apply for a car loan or a mortgage you have an ideal credit rating. Your credit score can impact the interest rate you are approved for.
A credit card application is often our first introduction to credit, so it’s not surprising that 9 in 10 Canadians have a credit card, with 25 percent having 3 or more cards.
Credit cards are typically the easiest form of credit to obtain. However, that doesn’t make them any less risky or troublesome. Nearly half (47 percent) of Canadians use their credit cards for 10 or more purchases per month, although 44 percent believe they have a poor understanding of the product. Even more alarmingly, 31 percent of respondents were unlikely to make their minimum monthly credit card payment. Remember, missing just one payment can lower your credit score and will stay on your report for seven years.
How does a credit card affect your credit score?
Everyone has a different comfort level and relationship with money. But, when money myths and misunderstanding are to blame, nobody comes out ahead.
Some may believe that the only way to build credit history is to carry a balance. This is false! The best practice is to pay your credit card balance in full every month. The only way to steer clear of credit card interest is to avoid carrying a balance. Surprisingly, 68 percent of Canadians are unaware that credit card interest is calculated daily on their balance.
Another 17 percent of Canadians cancelled a credit card because they believe it would improve their credit score. This is actually untrue. You’ll often see a slight drop in your credit score after you cancel a card, but this is usually temporary.
Paying your credit card bill on time, staying below 30 percent of your credit limit across all credit cards, and allowing your account to age, can improve your credit score.
Does having a joint credit card affect your credit score?
Before adding an authorized user to your credit card, would you stop to think “how might this affect my credit score?” With one in three Canadians sharing a joint credit card with their partner, parents or children, the answer may be startling.
Often the banks report authorized user activity to the major credit score companies; however, the actions of the primary cardholder may impact the authorized user’s credit, as they are responsible for paying the bill on time. On the other hand, authorized users can assist the primary cardholder’s utilization of the card. This category accounts for 30 percent of the FICO score.
Depending on the credit behaviour of all parties having a joint card, this may have a positive or negative impact on your credit score.
Why is using a debt calculator important?
Before committing to a new form of debt, plugging in the numbers into a debt calculator can help form a budget. For example, a Credit Card Debt Calculator can help you see just how much a loan will really cost you over an extended period of time with added interest.
In the case of credit card debt, it’s easy to make impulse buys with a quick tap or swipe. However, after seeing the added interest and understanding the true value of the purchase, you might reconsider its worth.
Before making a purchase with a credit card, consider:
- How long will it take to pay off this item?
- How much will it really cost me?
Not all credit is created equal, and credit cards have some of the highest interest rates across credit products. Paying off your high interest debt first and as quickly as possible may be the key to managing your money better.
Tracking your budget can be a useful tool to help you organize your spending. This way you can see where you may be overspending and need to cut back.
It can also be useful when coming up with a plan to manage your debt. Budgeting how much money can be allocated towards payments per month, as well as creating a timeframe, can make debt more manageable.
Tip: If the temptation to swipe or tap your card comes too easily, try using your card strictly for online purchases and bill payments. Using cash can be a more visual representation of how much money you are spending and how quickly.
Help to Manage Your Debt
Many people have a hard time talking about money and an even harder time asking for help regarding their debt. But, the longer you leave it, the more challenging it becomes.
Some options to consider are:
- Stop using your credit cards: The first step is to stop using your credit cards if you can and focus your budget towards paying off your balance.
- Balance transfers: Consolidating all your credit card balances on to one low interest credit card may help. Remember although most balance transfers have a promotional interest rate that increases once the initial offer lapses.
- Debt counselor: Speaking with a credit-counseling agency can help you develop a debt management plan. They may also negotiate with your lenders on your behalf.
- Speaking with your lender: Lenders ultimately want you to pay off your debt and they may have options in place to help you.