What Is A Credit Score? And Why Should You Care?
Alright, let's talk about credit scores! Think of your credit score as a report card for your financial behavior. It's a number that helps lenders, like banks and credit card companies, understand how likely you are to repay borrowed money.
Credit scores aren’t something you sign up for. If you have ever signed up for a credit card, taken out a loan (including student loans and car loans), or opened up a line of credit, you have a credit score!
There are 3 main companies, called credit reference agencies, that oversee credit scores: Equifax, Experian and TransUnion.
You’ve likely got a credit score with 2 or 3 of them (depending on where you live)! Note that each of these companies may have access to different information which means your credit score could be slightly different (one good way to get an average is to check your score from all three agencies).
The information that they store about you includes personal information, like your name and street address, and a detailed record of your financial history.
This record can include everything from knowing which credit cards you have and how often you pay them off, details on other loans you have (personal loans, car loans, etc,), if you rent a house or apartment they likely have details on your rental agreement, any agreements you have with service providers (like your gas provider, internet provider, cell phone provider, etc.), whether you’ve declared bankruptcy in the past, and they may even know if you have any court judgements against you!
Based on this information, these agencies generate a report about you, called a credit report, and they also give you a credit score.
A few things that credit reference agencies do NOT know about you are your income, the value of any of your savings or investments, or your medical history. Your credit report and credit score are constantly being updated whenever these agencies receive new information on you (like you paid a credit card bill on time or you missed a payment on your water bill).
A credit score is simply a number that estimates how likely you are to repay any borrowed money and pay your bills. Every country does credit scores a little bit differently, but they all tend to use similar scoring methods. In Canada, your credit score will range between 300-900, while in the US your credit score will typically range between 300-850, and in the UK your credit score will range between 0-999. In these countries the higher the score the better.
To find out more details on how credit scores work in your country, head over to Google and search for “How do credit scores work in [your country]” and read a few of the top results.
So, why are credit scores important?
Well, when you want to borrow money to buy a car, a home, or even for smaller things like a credit card, lenders will check your credit score to decide if they should lend you money and at what interest rate.
For example, someone with a low credit score may be given a higher interest rate on their mortgage than a friend who has a higher credit score, because they’re viewed as being higher-risk of not paying back the loan. And someone who wants to open up a new credit card or take out a line of credit may be declined because their credit score is too low.
Lenders may also look at your full credit report to learn more about your past use of credit to help them decide if you’re a good candidate for borrowing. There’s no hard rules when it comes to what makes an acceptable credit report or credit score- some companies might not care if you’ve currently taken out a loan for $30,000, while others might consider this risky.
It’s best to try to keep your score as high as possible so you’re in a great position when the time comes for you to apply for your next loan or credit card.
What Influences Your Credit Score?
Here are the main factors that influence your credit score:
Payment History: This is the most significant factor in determining your credit score. It reflects whether you've paid your bills on time, and if you’ve paid your bills in full or just made minimum payments. Late payments, defaults, and accounts sent to collections can all bring down your score.
Credit Utilization Ratio: This ratio compares the amount of credit you're using (utilization) to the amount available to you (your credit limit). For example, if you have 3 credit cards each with $5,000 limits, your total available credit is $15,000. If you’re regularly spending $12,000 across your credit cards (your utilization), it can indicate that you’re not managing your existing credit very well, even if you pay off all of your spending in full each month. It’s often recommended that you try not to use more than 30% of your available credit to show that you’re managing your credit well and are not a risk for lenders.
Length of Credit History: Lenders like to see a long history of responsible credit use. Your credit history starts the day you take out your first loan or sign up for your first credit card. The longer your credit history, the more reliable you appear to lenders.
Types of Credit Accounts: Having a mix of credit accounts, such as credit cards, installment loans, and mortgages, can positively impact your score. It demonstrates that you can manage different types of credit responsibly.
New Credit Inquiries: Opening several new credit accounts in a short period can be a red flag for lenders. It may suggest financial instability or a need for additional funds, which can bring down your score.
Public Records and Collections: Bankruptcies, foreclosures, liens, and accounts in collections can significantly damage your credit score so try your best to avoid these when possible.
Register to Vote: In some countries, registering to vote can help increase your credit score.
Where Can You Find Your Credit Report and Credit Score?
You can request your credit report and credit score anytime from the credit reference agencies in your country. Many agencies are required to provide you with at least 1 free credit report per year.
You can request your credit report and/or your credit score directly from these companies by heading to their website and putting in a request. Some banks have built-in integrations with the agencies so you may be able to check your credit score in your banking mobile app or website.
There are also several 3rd party companies that you can use to help check and monitor your credit score:
Borrowell in Canada
CreditKarma in the US, UK, and Canada
ClearScore in the UK, Canada, Australia, and South Africa
These 3rd party sites will often also send you updates each month to tell you how you’re doing and recommend tips to help increase your score if necessary. We love them!
Understanding Check Checks:
Anytime your credit is checked, a “check” or “inquiry” is recorded on your credit report. When it comes to checking your credit, there are two types: hard checks and soft checks. The type of inquiry depends on who is checking and why it's being checked.
Hard Check (Hard Inquiry): This happens when you apply for something like a credit card, loan, or mortgage. It's a deeper look into your credit history and can affect your credit score a bit. Having too many hard checks in a short time might make lenders think you're desperate for credit.
Soft Check (Soft Inquiry): This is more casual and doesn't impact your credit score. It's when you or someone else checks your credit for things like background checks, pre-approval offers, or even when you check your own credit report or credit score. Soft checks are like peeking at your credit without leaving any marks behind.
Put simply, soft inquiries don't affect your credit scores, but hard inquiries can lower your credit score.
It's always good to know which one is happening when you or someone else is checking your credit report so you’re aware if there may be any consequences! For example, if you apply for a car loan right before trying to close on a house you may find yourself with a higher interest rate or have more difficulty getting a mortgage because you’ve just had a hard check on your credit for your car loan and are now wanting to take out a substantial loan for a mortgage.
About The Authors
Amanda and Siobhan found a shared passion for personal finance shortly after completing their MBAs in 2018. Amanda excelled as a Director of Product in the tech industry, while Siobhan established herself as a leader in e-commerce before transitioning to academia as a Professor.
In 2020, they joined forces to found Hiver Academy, a platform born from their own experiences and triumphs in conquering student loans and building wealth. Realizing that financial success is within reach once the complexities are simplified, their mission now revolves around empowering individuals to achieve financial freedom.
With a wealth of knowledge and a commitment to demystifying money and investing, Amanda and Siobhan are dedicated to helping others navigate the path to success.
