What is a Credit Score and How do Credit Scores Work?


Simply put, there is so much more to understanding credit and managing it wisely than knowing your credit score – although that matters.

Today’s post will take you through the ins and outs of what your credit score is, how it is calculated, and why it should matter to you.

What is a credit score?

It has been written that much like a report card in school, we all have a credit score. We figure this is a good way to think about it since just like good letter grades in school, a good credit score can be a gateway to future success.

Like any report card, your (good) score can provide access to credit/lending that bad money management just won’t provide. Banks and other lending institutions in general, review your credit score when you apply for financial products such as credit cards. However, you should also know that your credit history may be checked by car dealerships, cell phone providers, landlords, and maybe even a prospective employer. So, like any report card, your credit score reflects your financial behaviour with debt and like most things in life, good behaviour is usually rewarded.

What is a good credit score in Canada?

Depending on the source, a good credit score in Canada ranges between the low-700s and at the very, very top 900. There are five general categories your credit score may fall into.

Borrowell Credit Scores

Image courtesy of Borrowell.

Many articles have been written about such scores but it’s important to understand there are many factors that can alter your score, and not all factors are weighted equally – some are more important than others.

How do credit scores work?

Here is what your credit score* consists of and the percentage weight of each factor.

Payment history35%
Credit utilization 30%
Credit history15%
Credit inquiries10%
Credit mix10%

*Weighted factors from Equifax.

Let’s break down each of these and why they matter to your credit score before we offer up some Frequently Asked Questions (FAQs).

  1. Payment history

As the largest credit score factor, this makes sense: kill debt by making those payments on time. Lenders want to see you’re diligent with your debt obligations. Miss a payment or payments and your score will tank. Declaring bankruptcy or having collection agencies come after you will significantly, negatively impact your credit score.

  1. Credit utilization

This is the ratio of credit available against the amount of debt owed. Where possible, keep your debt load as a percentage of available credit low.

  1. Credit history

Although not as important as your payment history or credit utilization, in terms of the weighting factor, the length of time you have used credit for any particular lender is important. Think of this as a trust factor. Keep a long credit history with some key lenders where possible, be diligent with your debt payments, and your score will be reflected as such. On the flip side, avoid cycling through new credit cards or loans every few months.

  1. Credit inquiries

We believe you should apply for new credit in moderation. Why? Recent “hits” on your credit will impact your credit score; this factor accounts for up to 10% of your score. There are however a couple of different types of credit checks you should know about.

  1. “Hard hits” are those related to new credit applications, which will lower your score especially if you have too many inquiries that occur within a short period of time.
  2. “Soft hits” are those inquiries related to your existing credit, such as credit card limit increases. Don’t worry too much about the “soft hits”, they don’t appear on your credit score and they don’t lower your credit score.

For example, a “hard hit” inquiry occurs when you apply for a credit card, a loan, a mortgage or other types of credit – essentially when a lender requests to review your credit report before approving any application.

  1. Credit mix

You can probably appreciate applying for a $500,000 mortgage will impact your credit score WAY more than a request for a credit card with a $25,000 limit. So, credit diversity and the mix is a factor.

How to obtain a “GOOD” or “EXCELLENT” credit score!

As you can appreciate by now, having a good credit payment history, is a great starting point for your solid credit score. To help you get a GOOD or EXCELLENT credit score rating here are some of our favourite tips:

  • Pay your bills on time. Don’t be late with anything including cell phone bills. Tip: set automatic payments or reminders to help you out.
  • Pay your loans off, fast. The faster the debt is done, the better your score and the more cash flow for you. Tip: consider snowballing debt (lowest debt first, paid off fast, then move on to next debt) to help you with your motivation while making all other debt minimum payments.
  • Keep your credit card balance ratio low. Tip: even if you have much higher available credit card limits, don’t use them. A lower ratio will help with credit utilization and avoid over-spending. Win-win!
  • If you do wish to try new credit cards, consider cancelling the most recent ones in your wallet. Tip: keep a couple of credit cards with a very long track record in your wallet, to support credit history.
  • Correct errors associated with your credit history, promptly. Tip: the longer errors persist the harder it might be to resolve bad credit.

Should you check your credit score?

Absolutely! It’s important to know your credit score as part of your overall health. Again, banks, lenders, and landlords are all likely to take your credit score in to account when you’re looking to get a mortgage, a personal loan, or any rental. Knowing your credit score and any details in your credit report can help you manage any application with confidence.

At Cashflows & Portfolios, we check our credit scores for free with Borrowell. We use Borrowell because:

  1. It’s free.
  2. It does not impact any credit score.
  3. It’s easy and available 24/7.

How do I check my credit score?

In the past, checking your credit score was a bit of an effort and came with a cost.  Today, there are many FREE ways to check your credit score.  Some options include:

  • Online apps – You can check your credit score for free with online apps like Borrowell (a partner of ours).  The best part? It takes less than 3 minutes and does not hurt your credit score at all. In fact, once you’ve signed up for Borrowell, they’ll analyze your credit report (more details on credit reports in the next section) to find out what’s impacting your credit score, how to improve your score, and what financial products may be suitable given your current score.
  • Your financial institution – If you log in to your bank account or credit card provider, there may be an option there to see your credit score.  From our experience, these are scores only without a credit report on existing loans etc.
  • Directly from Equifax and/or Transunion – Equifax and Transunion offer credit reports for free (but scores come at a cost).  Note that online apps and financial institutions pull their scores directly from Equifax, so no worries if you aren’t getting your scores directly from the providers.

What is a credit report?

Your credit report is not the same as your credit score. A credit report is a detailed breakdown of your credit history, provided by one of Canada’s credit bureaus (Equifax or TransUnion). If your credit score is like a report card in grade school, then your credit report is like a detailed report card from your teacher for every class in every subject.

Your credit report will show you in detail your history of approved credit, by whom, when, and any derogatory marks about you.

As mentioned above, with Borrowell, after you sign up, you get your Equifax credit report for free.

I’ve used both Equifax and TransUnion. Why are my credit scores different?

From Borrowell:

“The credit scores you receive from credit bureaus and credit score providers may be different because each company uses its own proprietary model to calculate your credit score. Note, however, that while the scoring algorithms vary, credit bureaus largely depend on the same factors when establishing your score, including payment history, credit utilization, length of history, types of credit and new credit.”

More credit score FAQs!

True or False?

1. Approaching your credit limit will not negatively impact your credit scores – False!

You know from above, even if you pay off your credit card balance every month, if your credit utilization is very high then there will be an impact on your credit score. Revolving debt can be a factor!

2. Closing an account will always help my credit score – False!

You should now know from above, that credit history is important. So, closing off a paid credit card, while very smart if not in use, can temporarily impact your credit score because it will impact your credit utilization/availability.

Since most of us have credit cards, from Equifax: be mindful of how they could impact your credit score.

3. Credit scores, credit reports and credit behaviour are unique – True!

Try not to obsess too much about your credit score. Sure, aim for GOOD or EXCELLENT ratings if you can but the reality is, everyone’s financial situation is unique. Focus on our tips above and that will put the odds of good credit in your favour.

Summary – What is a Credit Score and why does it matter?

Credit scores, credit reports and credit bureaus can seem complicated, but we hope this post helped demystify how credit scores work and how you can go about improving your credit score.

As mentioned above, we have partnered with Borrowell since it’s a service that we use personally.  By signing up with a free account with Borrowell, you get all the details about your credit and as a bonus, you help support Cashflows & Portfolios.

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