Your credit score isn’t something you likely ponder in your daily life. But when you need a loan, it matters a lot. This three-digit number is a critical factor lenders evaluate when deciding whether to grant you credit. In Canada, credit scores typically range from 300 to 900, with higher scores indicating better creditworthiness. The more creditworthy you are, the more likely you are to get approved for a mortgage, credit card, line of credit and other loans.
But what goes into calculating this number that can define your financial future? In this guide, we’ll walk you through the primary factors that impact your credit score and how much influence each has.
The five main factors that determine your credit score in Canada
Deciphering how credit scores work isn’t an easy feat. In fact, it’s downright impossible. The precise algorithms used to determine these numbers are a closely guarded secret. However, the companies developing these complex scoring models offer the public at least a glimpse into what makes them tick.
Most credit scores in Canada are derived from FICO’s scoring models, specifically Score 8. This model considers five main factors about a person’s borrowing habits: payment history, amount owed, length of credit history, credit mix, and new credit. Each plays a unique role in shaping your credit score, so it’s worth knowing what they mean and the impact each has. In doing so, you can better understand your credit standing and take decisive steps to improve it when necessary.
Payment history (35%)
Your payment history is the most influential factor in your credit score, accounting for 35% of the total. It’s essentially a track record that shows all the payments you made on your credit accounts.
Every time you’re late to pay a utility bill, mortgage payment, or minimum payment on your credit card, your credit score considers whether you were over 30, 60, or 90 days late. This category also looks at how often you pay late, how much you owe, and how recently you missed a payment deadline. In addition, it considers if you’ve had debts go into collections or ever faced bankruptcy, court judgements, and liens.
Payment history is something that lenders scrutinize closely, as they naturally prefer to lend to borrowers who are capable of paying on time. A string of on-time payments over a long period signals financial responsibility on the part of the borrower, which lowers the lender’s risk.
It’s always worth emphasizing the importance of payment history regarding your financial health. Even a single missed or late payment can result in a noticeable drop in your score. Late payments stay on your credit report for six or seven years in Canada, depending on the credit bureau.
But what constitutes a late payment? That depends on the lender’s policy. However, many lenders choose not to report late payments until they’re 30 days overdue.
Since payment history significantly impacts your credit, paying on time is a habit worth developing. The more often you pay late, the lower your credit score will fall. If you can’t make a payment in full, at least pay the minimum—your lender will record your payment as being on time.
Amount owed (30%)
The total amount of debt you owe is the second most significant factor is determining your credit score. This category also accounts for how high your balances are relative to your available credit and how much of your available credit you use routinely.
Credit usage is something that lenders closely evaluate when reviewing loan applications. Borrowers who carry a lot of debt are at greater risk of default. Conversely, those responsible for paying little debt are more likely to keep up with their payments. Naturally, lenders prefer the latter group.
This credit scoring category pays special attention to your credit utilization rate, which relates to revolving credit accounts like credit cards and lines of credit. This financial metric measures the portion of your credit limit that you’re using versus how much you have available. So, if you have a credit limit of $10,000 and your balance owing is $4,000, your credit utilization rate is 40%.
Credit utilization is calculated per revolving account and across all revolving accounts combined. So, if you use three credit cards, your credit score will reflect each card’s activity separately and the average of the three.
Therefore, a nifty way to increase your credit score is by opening a new revolving credit account and only using it occasionally. Your overall credit utilization will instantly drop since you have more credit room but are now using less. Or, you can say “yes” to a pre-approved credit limit.
Most financial experts recommend keeping your credit utilization no higher than 30% to 35%. The lower your credit utilization ratio, the better for boosting your credit score.
Length of credit history (15%)
This credit score component examines how long your credit accounts have been open. It emphasizes your oldest and newest accounts, but the average age of all your accounts matters, too. Credit history length makes up 15% of your credit score.
Why do lenders deem this factor relevant? The reason is it demonstrates you have experience handling debt—and experience (assuming it’s the good kind) signals financial reliability.
The longer your accounts have been open, the better your overall credit score will be. That’s why it pays to keep old accounts open, even if you no longer use them—they still contribute positively to your score. Credit activity automatically disappears from credit reports in Canada after six or seven years. For that reason, it’s worth using credit on an ongoing basis, even minimally, so you have something to report.
Credit history length can result in differences in credit scores, even among two people who diligently pay their debts on time. An 18-year-old who recently paid off their first credit card balance isn’t going to have the same kind of credit score as someone in their 40s who’s never missed a mortgage payment or utility bill. So, if you lack credit experience, consider becoming an authorized user on someone else’s account to start building a positive history.
Credit mix (10%)
Having a variety of credit products, such as a mortgage, line of credit, and personal loan, show lenders that you can manage different types of debts responsibly. This factor accounts for 10% of your credit score.
You don’t need every type of credit under your belt, but a mix of revolving credit (e.g., credit card) and installment loans (e.g., car loan) will improve your score.
It’s not necessary to open new accounts for the sake of diversifying your credit history. Borrow only when you need to and when it makes sense. Prioritize making on-time payments and keeping your credit utilization low instead.
New credit applications (10%)
This category considers whether you’ve recently applied for loans. More specifically, it examines the following:
- The number of times lenders have reviewed your credit report (also known as a hard inquiry or hard credit check) in the last few years
- The length of time that has passed since you opened your last account
- The timing of your most recent loan application(s)
Lenders examine new credit applications to learn about your current borrowing habits. For example, they may have concerns about your ability to make timely payments if you’re always shopping for a loan. A string of hard inquiries over a short time may indicate financial distress or reckless borrowing.
Each time you apply for a new loan, a hard inquiry is recorded in your credit report. However, an exception applies to certain loans, such as mortgages and auto loans. In such cases, multiple hard inquiries count as a single inquiry within a certain time frame. This grace period depends on the specific credit scoring model used by the credit bureau, but it’s usually between 14 and 45 days.
Hard credit checks stay on your credit report for three to six years, depending on the credit bureau that issues the report.
Note: When a lender pulls your credit report to pre-approve you for a loan, credit bureaus don’t register the act as a hard inquiry. The review is called a soft inquiry and does not impact your credit score. The same concept applies if you pull your own credit report.
The bottom line on how your credit score is determined
Your credit score can be the one factor that determines whether you get approved for a loan or rejected. It also affects your ability to obtain favourable loan terms, lower interest rates, and bargain effectively with lenders.
As a result, it’s wise to understand how your credit score is calculated and use this knowledge to your advantage. Monitoring your score regularly, making on-time payments, keeping your credit utilization low, maintaining long-standing accounts, and being mindful of new credit applications are steps to build and maintain a robust credit score. As Licensed Insolvency Trustees at David Sklar & Associates, we specialize in all debt relief solutions, including bankruptcies and consumer proposals. If you have poor credit and are struggling with unaffordable debt, learn about the role of a Licensed Insolvency Trustee and how they can help you get your finances back in shape. With patience, sound planning, and guidance from our seasoned debt experts, you can eliminate your debts and start fresh.
