Here’s what most Canadians likely know about their credit score: It’s a number somewhere on a scale from 300 to 900 — and the higher that number, the easier and cheaper it generally is to get credit.
If you want to take out a mortgage or auto loan, a good credit score improves your chances of being approved and getting a lower interest rate. A high score may also give you access to instant-approval credit cards and loans.
But here’s something you probably didn’t know:
No one really knows exactly how credit scores work
For obvious reasons, Canada’s two credit-reporting agencies, Equifax and TransUnion, do not reveal the exact formula through which they come up with credit scores. If they did, it would become easy for anyone to game the system.
The implication here is that most advice you get about how to improve, build or repair your credit score is really an educated guess. Based on anecdotal evidence and what they see dealing with clients, financial advisers have a pretty good idea of how different types of behaviour affect credit scores. But they can’t tell exactly how much of a difference each one really makes.
That’s why Douglas Hoyes, a licensed insolvency trustee at Kitchener, Ont.-based Hoyes, Michalos and Associates, is skeptical of strategies that entail taking out costly loans just so you can supposedly build or repair your credit score faster.
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Borrowing at, say, 30 per cent interest is guaranteed to cost you a pretty penny. The gain, on the other hand, it quite uncertain. Taking out a loan will definitely improve you score if you make your payments on time, but how much of a difference will it really make? No one can say for sure.
Given the uncertainty, Hoyes advises borrowing through the lowest-cost debt you can access and trust that your credit score will gradually improve if you keep on top of your finances.
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For those with no credit history or a poor credit score, a good first step is getting a secured credit card such as the Home Trust Visa, according to Hoyes. “Secured” credit means the lender will ask you to put down, say, a $1,000 security deposit for a $1,000 credit card limit. The point of such a credit card isn’t to borrow money to finance expenses for which you don’t have cash at hand but to show that you can make disciplined debt repayments.
Secured credit cards normally come with steep interest rates. The no-fee version of the Home Trust Visa charges interest of 19.99 per cent, but borrowers need not worry about it if they pay off their balance in full and on time, Hoyes noted.
Credit scores are designed with banks, not you, in mind
You might think that diligently paying off your credit card bills as soon as they come would get you the best possible score. You might be wrong.
Some financial advisers and debt management experts believe carrying a small balance of up to 30 per cent of your available credit on your card might actually boost your score more than having a balance of zero.
That’s because “credit scores are meant for the benefit of the banks, not you,” said Hoyes.
Banks are happy with customers who reliably repay their debt. But they also make money off charging interest. So they may be happiest with customers who will eventually repay their debt but keep carrying a balance, on which they’ll have to pay interest, explained Hoyes.
He advises doing what’s best for your pocketbook and skipping on financial behaviour that will ultimately cost you more — even if it means your credit score will be a bit lower.
Credit scores don’t matter as much as you think
A third thing to keep in mind about credit scores is that they aren’t necessarily the only metric a bank will use to assess your creditworthiness. “Banks may have their own formulas, too, which are different from whatever Equifax and TransUnion are using,” noted Hoyes.
Finally, he added, a bad credit score won’t shut you out of borrowing forever. Even bankruptcy is something you can recover from relatively quickly, if you have a good, stable job and show financial discipline, said Hoyes.
“I have plenty of clients who bought houses two years after being discharged from bankruptcy,” he told Global News.