Credit: Face your fear

 Credit: Face your fear – a Financial Literacy Month post

You can not overstate the importance of establishing a good credit rating, and the havoc a poor rating can wreak.

For better or for worse, it is perhaps the strongest factor in determining not only an individual’s creditworthiness but also their choices as they move through life.

Used once solely to establish trust between a borrower and lender, credit checks are now a common as part of the hiring process across a variety of professional industries.

Poor credit, left unchecked, can also affect an individual’s ability to continue their post-secondary education. Student loans of both the bank and government variety aren’t inclined to be kind in the interest of education, as naive borrowers quickly find.

What is it?

Credit is an established trust between borrower and lender that the amount borrowed will be repaid. Approval to borrow & terms of repayment are based on a variety of factors that determine an individual’s ‘creditworthiness.’

Back in the day, a person used to be able to stroll down to their local and leverage the relationship they’d built with their banker (through mundane chitchat about the weather) over the years to get a loan.

Lenders made decisions based on personal history with clients and their personal bias, instead of an impartial, calculated assessment of how creditworthy a client is. Your face and good name were enough to qualify, with sympathetic lenders, for a loan.

Today, not so much. The use, or misuse, of personal credit over a period of time is also a part of the calculation of what is known as a ‘credit score.’ Which determines if and how much a client qualifies to borrow.

Where does a score come from?

The first time a borrower applies for credit (to borrow money), their credit history begins. A record is held by at least one of Canada’s two major credit-reporting agencies (Equifax Canada and TransUnion Canada).

The credit score is determined by an evaluation of the borrower’s credit history based upon a secret formula (no, seriously) implemented by FICO in 1989. The exact mechanics of  remain a mystery, but FICO does provide the main components that factor into their calculations:

• 35 per cent payment history

• 30 per cent debt burden

• 15 per cent length of history

• 10 per cent types used

• 10 per cent recent applications

Payment History: Records of late paid bills, bankruptcy, liens, judgments, settlements, charge-offs, repossessions, foreclosures, and late payments can cause a score to drop.

Debt Burden: The amount of debt, debt to limit ratio, accounts with balances, amounts owed across varying types of accounts, and amounts paid on installment loans are all considered in calculating a credit score.

Length of History: The average age of all accounts on a credit file, as well as the age of the oldest account, both in score calculation.

Types Used: A history of managing different types of credit (installment, consumer finance, mortgage) can benefit consumers positively in score determination.

Recent Applications: Frequent applications for credit can negatively impact a score.

Clinton’s Final Word:

The best time to check your score and take action was when you began your credit history. The second best time is now.

Personal reports are easy, freely obtained, and our next post will be focused on taking action to improve credit scores, once our readers have had a chance to assess their individual situations.

It’s never too late to change the way you view and handle your finances, or transform anxiety into empowerment.

Clinton & Team

Have more questions? Feel free to contact us!