Credit Scores: Everything You Need to Know

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Editor's Note: This story originally appeared on Point2.

When buying a new home, the majority of us need to take out a mortgage. But, in order to qualify for this loan, lenders will scrutinize your credit report and credit score. What they find (or don’t find) will influence their decision regarding whether to approve the loan, as well as the amount they’ll lend you and the interest rates you can expect to pay.

That’s why it’s important to understand what a credit score is and what you can do to ensure that yours is the best it can be.

In this guide, we’ll break down all of the key information into easy-to-manage chunks. So, whether you want to know who calculates your credit score, how to check it or what a good credit score is, we’ve got you covered.

The Basics: Defining Credit Scores

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In a nutshell, a credit score is a number that depicts your credit risk to lenders — the higher the number, the lower the risk. Meanwhile, a lower score represents a lower level of credit trustworthiness. In the U.S., credit scores range from 300 to 850, while in Canada, they go from 300 to 900.

Your credit score dictates the state of your financial health, and various institutions use it in different ways. Most commonly, it’s used by lenders to discern whether they should lend you money for anything from a new home to a cellphone contract.

Your credit score will also have an influence on the type of loan you’ll get. A higher score will result in more attractive interest rates, as well as a higher credit limit. Conversely, a low credit score can result in poorer interest rates and a lower credit limit. So, when you’re looking to buy a home, it’s well worth bringing your credit score up as high as possible.

Is a Credit Score the Same as a Credit Report?

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While the two terms are often used interchangeably, credit scores and credit reports are different.

A credit report details both your credit history and current credit products. The report is compiled by credit bureaus when you first apply for credit and then updated with information from your various lenders and other creditors throughout the years.

Your credit report is also used by lenders to determine your creditworthiness. That’s because it offers a far more detailed look at your financial health than your credit score alone and, therefore, can affect whether you qualify for a loan. A credit report shares two types of information:

  1. Identity: Name; contact details; date of birth; NIN (National Identification Number, U.S. only); current employer; and employment history
  2. Credit history: Credit utilization; payment history; current credit products; financial problems, such as missed payments and bankruptcies; hard credit inquiries (more about that later); and information regarding each loan/product, such as date opened and remaining balance

Note that your credit report doesn’t include current bank statements, cash payments, income information or personal information, such as your criminal record or medical history. Your actual credit score also isn’t included in the credit report.

However, your credit report is used by credit bureaus to calculate your credit score — and, as the information in the report changes, so does your score. It’s also worth noting that information doesn’t stay in your credit report forever. Negative information — like missed payments or bankruptcies — will be removed after seven years. The influence they have on your credit score will also dwindle over time. However, positive information, including successfully paid loans, will remain in your report for about 10 years.

Who Calculates Your Credit Score?

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So, who are the credit bureaus that are responsible for compiling your credit report and calculating your credit score, and what exactly do they do?

In the U.S., there are numerous credit bureaus, also known as consumer credit reporting agencies. However, of these, only three are nationally important: Equifax, Experian and TransUnion. In Canada, Equifax and TransUnion are the two major agencies.

Each of these companies collects, analyzes and distributes consumers’ credit information. They obtain their information from creditors, such as credit card companies and banks, as well as courthouses and governmental agencies. Then, once they’ve created your report and calculated your score, they distribute the information to lenders, insurance companies, service providers and anyone else who wants to look at your credit history — including you. You can contact the credit bureau of your choice directly for a free annual credit report. We’ll take a closer look at that a little later.

How Is a Credit Score Calculated?

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Credit bureaus in both Canada and the United States use either the FICO or VantageScore credit rating system as a basis for calculating your credit score. But, before we see what influences your credit score, let’s quickly cover the differences between the two models.

FICO Versus VantageScore

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FICO uses information from Equifax, Experian and TransUnion to develop its score, whereas VantageScore is a model created by these three agencies.

While FICO is, by far, the more popular model (preferred by around 90% of lenders), VantageScore is said to give a more accurate representation of a consumer’s credit habits. For example, VantageScore uses machine learning to differentiate between different types of late payments, thereby giving harsher penalties for missed mortgage payments and lower penalties for smaller mishaps. Alternatively, FICO treats all late payments the same.

The way the scores are represented is also different: FICO creates three different scores, one for each of the bureaus studied. And, because the information from each agency may be slightly different, the three scores are likely to be different. Meanwhile, VantageScore provides a single figure that combines information from all three bureaus.

Main Factors That Contribute to Your Credit Score

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While the exact formulas used by FICO and VantageScore are not released to the public, the five major factors that are used to calculate your credit score are available. So, although you’ll never be able to accurately calculate your credit score yourself, you can at least get a good idea.

Payment History (35%)

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Accounting for 35% of the credit score, your payment history is the most important factor when it comes to calculating your credit score. Essentially, this factor considers your ability to make loan repayments on time. It also details any missed payments and how often this occurs, as well as how many delinquent credit accounts you have.

Information is gathered from all of your credit products, including auto loans, credit cards, cellphone contracts and student loans. Each product will have a separate entry on your credit report (including closed accounts), with each section detailing whether you’ve repaid or are in the process of repaying what you owe. Listed in chronological order, older entries will have less of an influence than current entries.

Available Credit (30%)

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One of the most important factors (as far as lenders are concerned), this item determines how much of your available credit you’re using. In a nutshell, it shows what you already owe and whether you’re in a position to take on additional debt.

Also known as the credit utilization ratio, it’s expressed as a percentage. Ideally, you should aim to use less than 30% of your available credit. However, if you’re regularly maxing out your credit limit, lenders will see you as a higher risk.

Length of Credit History (15%)

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This section details how long you’ve actively been using credit. For this metric, an average is taken from all of the accounts you have open. So, the more new credit products you sign up for, the younger your overall account will appear. Notably, lenders always favor long-term credit history as it shows that you’re able to handle credit responsibly for an extended period.

New Credit & Inquiries (10%)

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Every time you request a new credit account, the lender will need to initiate a “hard check” as they view your credit report. During a short period of time, several hard checks like this can lower your credit score and make lenders wary. That’s because, to them, it looks like you could be in financial difficulty and might be trying to take out more credit than you can afford to pay back.

Credit Diversity (10%)

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This last factor details the different types of credit products you own. A diverse range of products — including installment credit, like auto loans, and rolling credit, such as credit cards — will generally work in your favor. Credit diversity shows that you’re able to sensibly manage a variety of different credit options.

However, lenders reviewing your types of credit may also find red flags. For instance, numerous payment plans might indicate that you struggle to save up for large purchases, while a consolidation loan could suggest that you’ve struggled to pay off your other debts on time.

What’s a Good Credit Score?

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Every lender has its own definition of what a good credit score looks like. That said, the following average FICO score range is frequently used when you’re being considered by lenders.

United States:

  • 800 – 850: Excellent
  • 740 – 799: Very Good
  • 670 – 739: Good
  • 580 – 669: Fair
  • 300 – 579: Poor

Canada:

  • 800 – 900: Excellent
  • 720 – 799: Very Good
  • 640 – 719: Good
  • 580 – 639: Fair
  • 300 – 579: Poor

These averages give you a rough idea of where you stand with a lender. But, for a little more nuanced look at how each score range affects you as a borrower, let’s break things down a bit more.

What Does an Excellent Credit Score Mean?

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Anything above a FICO score of 800 is considered excellent in both Canada and the U.S. If this is your score, you’re a lender’s dream client — an excellent borrower who is unlikely to default on the loan. Moreover, this gives you considerable negotiating power as you will essentially have your pick of lenders. In this situation, you’re almost certain to be approved for a loan and will typically be offered the best interest rates and lending terms.

What Does a Very Good Credit Score Mean?

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A FICO score between 720 (Canada) or 740 (U.S.) and 799 is typically considered very good. It shows the lender that you’re a dependable borrower, and you’re very likely to have your loan application approved. You’ll also be eligible for lower interest rates.

What Does a Good Credit Score Mean?

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In Canada, a good FICO score ranges from 640 to 719. For the most part, Canadian lenders will find this range acceptable and even the top lenders will generally accept any score above 680. In the U.S., a good score ranges between 670 and 739 and will typically allow you to qualify for a loan. However, in both cases, you’re unlikely to qualify for low-interest rates.

What Does a Fair Credit Score Mean?

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In Canada, a FICO score between 580 and 639 is considered fair. For most lenders, this will signal that you’re a risky borrower, but it doesn’t mean that there’s no hope. The minimum credit score for mortgage approval in Canada is 600. Notably, the national average credit score is around 650. So, while you may qualify for a loan, you’ll generally have to deal with higher interest rates.

In the United States, a fair score ranges from 580 to 669. People with a score below 640 are considered sub-prime borrowers, and while they’ll still generally qualify for a mortgage, they’ll also be subject to higher interest rates. Those with lower scores may also be given a shorter repayment term, or lenders may require a co-signer.

What Does a Poor Credit Score Mean?

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In both Canada and the United States, a credit score of less than 579 is considered poor. Lenders will see you as a very risky borrower, and it’s unlikely that you’ll qualify for a mortgage.

How Can You Check Your Credit Report?

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You’re entitled to view your credit report for free in both the United States and Canada. It is worth checking, as every now and then mistakes can be made, which can lower your credit score. However, it’s normally easy enough to have these removed.

Each of the major credit bureaus is required to provide a free copy of your credit report and you can reach out directly via their websites. In the U.S., you’re entitled to one free credit report per year from each bureau. (During the pandemic, each has made free reports available weekly, an offer now valid through 2023.) In Canada, Equifax provides the information each month for free to all Canadians.

Again, you won’t see your credit score on the report, but you can pay to see it by submitting a request on the FICO website. There are also free online services that also offer your credit score, although some might require a monthly subscription. Nowadays, numerous credit cards and bank accounts will tell you your credit score on your monthly statement.

Will My Credit Score Fall When I Check It?

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Checking your own credit report or score will have no influence on your score, as it’s considered a soft check. A hard check occurs when a lending institute looks at your credit report (with your permission) in order to approve or deny your loan request. These hard checks do reduce your credit score, especially if you have too many in a short time frame, which can indicate financial stress.

Ways to Improve Your Credit Score

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Your credit score is in constant flux, rising and falling as you use (or don’t use) your credit products. However, you also have a lot of control over it. Below are several ways to improve your credit score before you start house-hunting.

1. Don’t Miss a Payment

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Regular late payments are a sure way to bring down your score. Fortunately, after six months of unmissed payments across all of your lines of credit, you’ll start seeing your score increase considerably. If possible, try to pay your bills early.

2. Reduce Your Credit Utilization Rate

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Your credit utilization ratio is an important factor and, ideally, you should aim to get it below 30% if you can. This can be achieved by increasing some of your credit lines. For instance, you can speak with one of your credit card suppliers and ask them to increase the limit. They typically will if you’re in good standing. Just be sure not to use the extra credit to maintain a lower utilization rate.

3. Avoid Opening New Lines of Credit

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If you’re planning to buy a home, it’s best to avoid taking out other new loans in the six months or so leading up to it. That’s because each new request will negatively influence your score twice. First, the hard inquiry will lose you some valuable points. Second, you’ll reduce the overall age of your credit accounts.

4. Don’t Close Unused Accounts

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Rather than closing accounts that you’re not using, it’s generally better to keep them open and use them for small purchases. This helps to maintain a healthier credit utilization rate and a longer account history.

5. Check for Errors

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Around 80% of credit reports are believed to contain errors of some sort. Worse still, 1 in 20 are believed to contain errors that can seriously harm your credit score. For this reason, be sure to check your credit reports before applying for a mortgage and have any errors removed first.