The purpose of today's post is to:
- explain how to obtain a credit rating without impacting your record;
- provide easy actionable steps to improve your credit rating.
Alarming Consumer Debt Statistics
Equifax, one of Canada’s two credit rating agencies (TransUnion is the other), released a report in December 2016. It revealed that low-interest rates and falling oil prices have contributed to a rise in consumer debt and delinquency rates in the 3 month period ending September 30, 2016.
It found that the Canadian consumer increased their average debt by 3.6% to $22,081 compared to the same period in 2015. Their report also noted that, all told, Canadian consumers owed $1.702 TRILLION compared to $1.587 TRILLION a year earlier.
I was alarmed to learn that the population aged 65+ experienced the highest growth in average outstanding debt ($15,238 or an 8.3% Average Debt Change YoY (Q3 2016 vs. Q3 2015)).
Another finding was that the overall delinquency rate jumped from 1.05% (Q3 2015) to 1.14% (Q3 2016).
Credit Scoring Overview
A high level overview of the credit score ranges for the 3 credit bureaus which operate in the US (Experian, TransUnion, and Equifax), can be found here; Canadian readers should note Experian does not have Canadian operations.
Credit scores can fall anywhere between 300 and 900. While every lender has its own criteria, a good credit score could be anything above 650-680.
Lenders view borrowers with higher scores as less risky. Each financial institution, however, has its own rankings for high and low risk borrowers.
Each credit bureau has its own scale. This chart, for example, lays out Equifax's scoring system.
|300 - 499||Very serious issues. Difficult to get any credit.|
|500 - 574||High risk customer. May be required to provide securitization.|
|575 - 649||Above average risk profile. May be granted credit with high interest or low limits.|
|650 - 749||Fairly safe credit risk for most institutions.|
|750 - 900||Safe credit risk. Generally approved easily.|
"Soft Check" and "Hard Check" Credit Inquiries
The credit rating agencies offer “soft checks” and “hard checks”.
A “soft check” is when you check your own score or a business takes a peek in order to offer goods and services.
A “hard check” is when a financial institution or business examines your creditworthiness.
If a creditor performs an inquiry, the inquiry appears on your credit report. If a potential creditor sees multiple instances in which inquiries have been performed on your credit report, it suggests you are fishing around for credit. This might make the potential lender nervous and might be a sufficient reason to pass on your credit request.
How to Obtain a Your Credit Rating
US residents can obtain a free credit report here.
If you are a US residentand alternative is to obtain a free credit report by going here.
Steps to Build and Maintain Your Strong Credit Rating
Here are some tips to help you build and maintain a strong credit rating.
Stay Within Your Credit Limits
Credit limits serve a purpose. Don’t exceed them and don’t consistently maintain balances that approach the credit limit. Keep your credit balances under 35% - 40% of the limit. If this means you need to make payments more frequently than once a month, then so be it.
Pay Your Bills on Time
The best way to improve your credit score is to pay ALL your bills on time.
- you have been tardy in paying your bills, your credit score may be in the 600 range;
- you start paying all your bills on time, and you catch up on all arrears, it could take you upwards of a year to boost your credit score to 700;
- your credit score is sub 500 (ie. bankruptcy), it could take 2 – 3 years to repair your credit.
Pay Off the Highest-Interest Debt First
Two factors to consider when determining what debt to repay first are:
- the rate of interest being paid;
- is the interest on the debt tax deductible?
Given the above, credit-card debt incurred for consumption purposes should be repaid first...even before student loans and mortgage debt.
Repay non-tax-deductible debt before valid tax-deductible debt. If you are an investor who employs debt to acquire income generating investments such as stocks in taxable accounts, the interest on this form of debt is usually tax-deductible
If you borrow to acquire a rental property, the interest on this debt is also generally tax-deductible. Therefore, if you have incurred debt to purchase equities or rental properties AND you also have an outstanding mortgage on your principal residence where interest is not tax-deductible, you want to make the repayment of the mortgage on your principal residence a priority.
Note: Interest on an investment related loan secured by your principal residence would most likely be tax-deductible. I say most likely because there are exceptions. Seek advice from a reputable accountant and lawyer.
Avoid Retail Credit Cards
Each time you apply for a retail merchant’s credit card, a credit card application will trigger a “hard check” credit inquiry. Each “hard check” inquiry lowers your credit score by seven points.
If your score is around 700 and you are looking to make a major purchase (eg. vehicle or house) do not apply for a couple of retail cards beforehand. These retail card applications will trigger credit inquiries that could lower your credit score to the extent where you may no longer qualify for the best interest rates for your major purchase.
Check Your Credit Scores from Both Ratings Agencies
Check your credit scores at least once a year to ensure there are no surprises or errors.
Obtain credit reports from both Equifax and TransUnion. They could have different scores for you since they only synchronize their scores every couple of months.
Build a Credit History
Chances are you have a low credit score or no credit score if you have no borrowing track record. This is because lenders have nothing by which to gauge your credit worthiness.
If you have a credit card you never use, increase your credit score by making occasional purchases and paying off the balance owing before the due date.
Obtain Your Credit Report
Everyone should know their credit rating. Obtain your credit rating at least annually.
Use the tips provided in this post and check out the following sources to help you with the process.
US residents can use this source to obtain credit reports.
You can also obtain credit reports and register for additional services each credit reporting service provides by going directly to their website. Canadian residents should note that Experian does not operate in Canada.