Understanding Credit Score

Understanding Credit Score

So my posts of intrigued you and you want your shot at the big time eh?  No problem but before we run, let’s learn how to walk.

This first thing I tell my clients is that if you want to play in the Travel Hacking game, you should never carry a balance on your credit cards.  With cards that provide high sign up bonuses, your interest rates tend to be very high if you carry a balance.  These high interest rates immediately kill any benefit of the points you earn so DO NOT CARRY A BALANCE.

Now most of you have probably heard of the term Credit Score but what is it and how does it work?

Your Credit Score is a quick and simple way for credit lending agencies to judge your creditworthiness.  Rather than go through all your previous loans, credit cards, payment history, etc., the credit rating agencies (TransCanada and Equifax) have developed a simple no nonsense way to distill all of your credit activity into a simple score.

This score allows people that aren’t experts in credit to make a determination of whether or not to lend to you.  As an example, a credit card company might make a rule that says “if Customer X has a credit score above 700, we will provide him/her a credit card”.  Of course there are other considerations but as a simplified anecdote the above is how credit lenders make their decisions.

How Is Credit Score Calculated?

credit-score-pie

The pie chart above shows how credit lending agencies assess you and how they determine your credit score.  Let’s look at this category by category.

Payment History (35%) – Your payment history is the largest single aspect of your credit score and it helps lenders understand if you pay your bills on time.  There’s not much to understand here.  If you pay your bills on time, your score goes up.  If you don’t your score goes down.  This is the easiest aspect to explain and understand.

Simplified – Does this person pay their bills on time?  They do?  Great.  They will probably pay our bill too.

Capacity (30%) – Capacity is sometimes known as your debt service ratio.  This aspect measures how much credit you have and how much have you used.  As a simplified example, if you had one credit card that had a limit of $1,000 and you had $500 outstanding when your credit card cycle billed, you would have a 50% debt service ratio (aka capacity).

Now if you had 2 credit cards, each with a $1,000 credit limit and still had the $500 outstanding, your debt service ratio (aka capacity) is decreased to 25% ($2,000 / $500).

Simplified – Does this person use their credit responsibly?  They do?  Perfect.  They are likely to do the same with us.

Length of Credit (15%) – How long have you had your credit lines?  This is a really easy one to understand as well.  Remember that Rogers account you had when cell phones came out?  Ya, me too.  Turns out that that was my longest revolving credit account and it helps your credit score because the longer you have your credit with the same lender, the more stable you look to lenders.  The key here is to keep your lines of credit open for as long as possible.

In practice, I will get a credit card that offers the First Year Free (FYF) for the annual fee and when it comes time to renew the card, I will try to get the annual fee waived or move the card to a no annual fee card.  When I move to a non annual fee card, that card then goes into my drawer never to be used again.  Now I have a card that will indefinitely provide me value by increasing my average age of accounts.

Simplified – Does this person move from credit card to credit card?  No?  Perfect, they are likely to be a loyal customer to us.

Accumulation of Debt (10%) – This is the category that addresses how often you are applying for credit.  While it is true that every time you apply for credit, you decrease your credit score but the decrease is only based on this category.  If you are seen to be applying for credit on an ongoing basis, it might indicate that you are in financial difficulties, especially if those applications result in lenders declining to provide you credit.

Simplified – Does this person apply for credit all the time?  No?  Perfect.  They most likely aren’t in any financial difficulties.  Let’s give em a card.

Mix of Credit (10%) – This category is probably the most difficult to understand because there’s no real answer on how to properly shape your portfolio.  What lenders are looking at here is what kind of credit are you applying for?  Most people have a mix credit cards, loans and mortgages in their debt portfolio.  Here lenders are looking to see what kind of obligations you have.  If you have a consolidated loan, this might indicate that you have troubles paying your debt and need help, whereas if you had a mortgage and credit cards as your only debt, you might look very appealing.

Simplified – Does this person have a bunch of consolidated debts or loans with deferred interest?  No?  That’s great.  They look like they manage their finances correctly.

What’s a Good Credit Score?

Everyone wants to know what their credit score needs to be in order to play in this game.  Well the answer is “it depends”.  I have a credit score that hovers in the high 600s and the low 700s due to our mortgage in ridiculously expensive Calgary (thanks Obama), and I get approved for every card I apply for.

If your credit score is 700 or above, I would say that you are a prime candidate for Travel Hacking, however, I have heard that people with scores as low as 650 get approved for most cards.

How Do I Find Out My Credit Score?

In the past, you had to pay Equifax or TransUnion for your credit score where our neighbours to the South enjoyed free credit scores.  Well, time heals all wounds because we now have the same benefits!

Canadians can now enjoy getting their credit score for free from a couple of sources.

Thanks to a reader of PointsNerd it has been pointed out to me that if you are a resident of Quebec, you may not be able to check your credit score through these channels.

A note here.  These companies provide you your credit score for free (usually $19.99 from Equifax or TransUnion for each inquiry) in exchange for peddling you loans, credit cards, etc.  You have no obligation to use them but that’s the deal.  You give and you get.

Now there are two companies that currently provide your credit score for free and both are accurate.  I have compared their scores against my score from Equifax and they are one in the same.

 

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Borrowell.com– this company will provide you with a credit score in as little as 3 minutes and will provide you with an updated score every 3 months … for free.

 

mogo_logoMogo.ca – similar to Borrowell but Mogo provides you with a free update of your credit score EVERY MONTH!  For free!

I Have My Credit Score … Now What?

Now that you understand credit score and what your personal credit score is, we need to know what cards to apply for.  Follow along with this blog as I will run through all the current credit card offers of interest for Canadians.  I intend on covering off one card a day for the next week or two and mixing in a few tips and tricks along the way.

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