When my parents got married and wanted to get their first home my grandparents were asked to co-sign. The loan officer at the time asked my grandfather if he had good credit to which he replied “I have great credit. I never borrowed a penny in my life.” Unfortunately that is not what the bank had in mind and my parents had to wait a few years to buy go thru this process.
Credit for a lot of people is a very secretive, confusing and usually annoying topic. Keeping it secret from the public is a good idea; however it does not have to be confusing or annoying. It is all around us from the time we get a Social Insurance Number. From that moment on we are tracked by Credit Reporting Agency and our history writes itself. How it is written is up to you. Learning to understand, deal and manage credit will make our lives easier, lead to quicker wealth and access to one thing we all want: CASH!!!
In 1956 the Fair, Isaac & Co. developed a statistical system to measure and predict consumer ability to repay debt. The system was based on a scale from 300 to 900 and was called FICO Credit Report and FICO Score. Today the reports are used to qualify consumers for a range of products like insurance, renting, employment and lending money. If your reports contain unfavourable information insurance companies may not offer you insurance as you are more likely to make claims due to lack of cash flow. Landlords may be reluctant to rent due to payment problems and outstanding large debts.
North America has three major Credit Reporting Agencies for Canada and the United States. While reporting practices and operations may be similar, each report differs by region and agency. Equifax Canada Inc., TransUnion of Canada, and Experian Consumer Direct are the three leading agencies in Canada. Although the reports are different your scores should be within 20-30 points of each other. It is highly recommended to review at least one report per year and correct any discrepancies in your records. Institutions must retain your consent for seven years if they access your records. Check for inquiries on your report that may not be authorized or you don’t recognize. This may be a sign of identity fraud, which is a growing problem in the financial industry.
Credit is a very fundamental aspect of our economies. Every day we borrow or extend credit. When we pay tuition upfront or gym memberships we are extending short term credit. Lending friends clothes is extending credit. When we use our credit cards or personal credit we are borrowing. Mortgages and lines of credit are other cheaper lending alternatives. The interest rate is set by the overnight rate of the Bank of Canada. This is the rate the government lends to banks at. Banks usually will charge a compound interest which increases the outstanding amount and takes longer to pay off. This is usually referred to as the cost of borrowing.
So what exactly is in your credit report? The answer is more detailed and specific then most imagine. Your credit report has 9-12 different sections. The first section will include your name, date of birth, age, address, social insurance number. Another section will have a list of all the inquiries or hits into your history. Some lenders recently started to do what is called a “soft hit” which actually does not show up on your credit report and does not affect your score. Here you will see what institution accessed your report, and what date.
Your employment history and residence history is on your credit report as well. This is actually a very useful tool. When applying for a loan, when your information does not match it sends warnings to lenders and the credit bureau is notified of a possible identity theft. Lenders will also be able to verify your credibility and your honesty when they crosscheck your application with your records. The length of employment shows stability and increases the possibility that someone will be able to meet their financial obligations. Living at the same address for a few years shows lenders that you are capable of making regular long term stable payments. This does not affect the lending decision too much but can be a swaying factor.
The FICO score is one of the biggest anomalies to consumers. The reason, it is always being tweaked and changed. Your score can drop 50 points in a single reporting period if you near your credit limit by $100 in a month. The score is made up of five parts:
• 35% payment history: if you have paid your bills on time, no late payments, overdue amounts, is it revolving credit or a monthly instalment like a car loan. Pay your bill on time. At least pay the minimum. Make sure you let your transactions register on the lenders system so it gets reported and your history is being updated. Remember you have a 30 day grace period on most credit cards.
• 30% amount you owe: this is a key part which you can control. If your credit limit is $1000 on a credit card your goal balance should always be between $250- $350. This way your debt ratio is only 25-35%. It does not look like you are over extended and have no difficulty paying your balance if necessary. If you start going close to your limits on your credit, bureaus will enter CAPITALIZED warning notes on your file to show this is a regular occurrence. DO NOT go over 75% of your credit limit unless absolutely necessary.
• 15% length of credit: the longer you have had an account in good standing the better. Close newer account with higher interest rates, but keep the older ones open and use them continuously. There is something ingrained in nature about grandfathering old things that have been with us for a long time.
• 10% type of credit: whom you borrow from is just as important as the rate. Products from big banks like line of credits or credit cards look more favourable then financial creditors like Future Shop or Citi financial. Also, if you are constantly borrowing from Cash Advance places or credit cards approach your bank. Mortgages can be from anyone as they do not show up one your report.
• 10% new credit: avoid applying for credit unless you have to. Too many new credit hits from credit card companies or department stores lowers your scores. These now become new risks that have to be paid and maintained. This makes you look like a credit seeker and may be a sign your financial situation is worsening. Remember the money you save on the discount will cost you many times over in the future.
The trades section holds all the different types of credit that you have. Here you can see how long your account has been open. The status of the account and if it is in good standing is listed. Any delinquencies that occurred in the past 12 months and the credit limit for products are listed, ex R9’s. Some trades may not be up to date, as each lender has different reporting requirements. There is no mortgage info on your trades or credit report, however bankruptcies are noted in regards to real estate.
Continued: Understanding Your Credit Score 2 of 2