What 5 main factors determine your credit scores?

Group of friends talking about credit scoresImage: Group of friends talking about credit scores

In a Nutshell

How are your credit scores decided? The main factors that affect your credit scores include your payment history, variety of credit types, credit utilization,  length of credit history and credit inquiries.
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A credit score is a three-digit number that some companies and organizations use to determine your creditworthiness — or your ability to pay back your debts and make other monthly payments.

When you apply for more credit, the financial institution will likely check your credit scores, and use it to decide if they’re comfortable lending to you, how much they’ll lend you, and at what interest rate.

Your credit scores may also matter when you apply for an apartment or job, or when you apply for insurance in some provinces.

While your credit scores can look slightly different, depending on which credit bureau it’s pulled from (Equifax or TransUnion), the same five factors are primarily used to determine the final number.

Here’s an explanation of each factor and how you can stay on top of them.

1. Your payment history

“The most important factor in building and maintaining your scores is to pay your bills on time because it shows lenders your ability to responsibly manage credit,” says Heather Battison, former vice president at TransUnion.

On top of detailing whether or not you’ve paid your bills on time, your payment history may also show bankruptcies and any debts that have been sent to collections or written off. These negative marks could significantly damage your credit scores.

If you think you can’t pay a bill on time, the Financial Consumer Agency of Canada (FCAC) suggests contacting your lender immediately to see if you can make a special arrangement to repay your debt.

2. The types of credit you have

The different types of credit accounts you have is another piece of the puzzle that makes up your credit score calculation.

According to the FCAC, it’s preferable for you to have access to more than one type of credit. This is because both lenders and credit bureaus want to see that you’ve handled multiple types of credit well.

Common types of credit accounts include:

  • Credit cards
  • Mortgages
  • Auto loans
  • Student loans

According to the FCAC, a mix of credit accounts may help you achieve higher credit scores — however, it’s strongly recommended that you only open credit accounts that you need and make full, on-time payments.

3. Your use of available credit

One of the most important numbers that goes into your credit scores is the percentage of available credit you are currently using — known as your credit utilization.

To calculate this for yourself, add up the balances of all your credit card accounts and divide it by your total available credit.

For example, if you are currently using $2,000 of your $10,000 limit, you would divide $2,000 by $10,000, multiply that figure by 100 and find you’re using 20% of your available credit.

In Canada, your goal is to keep this number under 35%. Going above this could hurt your credit scores and ability to borrow more money.

“If your credit utilization is low, it’s an indication that you’re a responsible spender and can appropriately manage your debt,” Battison says. “Conversely, if your credit utilization is high, you can appear risky to lenders who may question your ability to pay back your loans.”

4. The length of your credit history

The length of time you’ve had your credit accounts open could also impact your credit scores.

The rule of thumb is that the longer you’ve had an account open for (and actually use it), the more this may help your credit health.

To that end, closing old accounts can damage your credit scores, as it will shorten the length of your credit history.

Closing an account can also hurt your scores if doing so means you’ll be using more than 35% of what’s available of your leftover credit, or if it means you have fewer types of credit (credit cards, loans, line of credit, etc.) available to you.

It’s a smart idea to keep your oldest credit account open and use it occasionally, so long as it’s not costing you more than you’re getting out of it.

5. The number of credit inquiries on your report

Your credit scores can be affected by the number of times you try to open new credit accounts.

Remember: Whenever you try to open a new account, the lender will check your credit report — and that’s reported as a “hard hit” inquiry, which could affect your overall scores.

A hard hit inquiry (sometimes referred to as a hard inquiry) is a credit check that’s recorded in your credit report, which will be seen by anyone who checks it in the future.

Examples of hard hits are credit card and loan applications, as well as some rental and employment applications.

Conversely, whenever you check your own credit scores, that is known as a “soft hit” inquiry. Soft hits aren’t recorded in your credit report, and therefore won’t affect your credit scores.

If you’ve applied for credit multiple times in a short window of time, it can damage your credit scores. For that reason, it’s important to only apply for credit when it’s absolutely necessary.

However, there is one exception to this – if you’re shopping around for the best rates for a car loan or mortgage, if these multiple hard hits are recorded within a two-week period, they’re treated as a single inquiry on your credit scores.

About the author: Cait is a freelance writer and editor in Squamish, BC, Canada. She writes about simplifying finances and living a more intentional life on her blog, CaitFlanders.com. Read more.