Bits and Bytes about Credit Score
- by Monica J. Weissmann, CFP, CIM, MEE
The word "credit" holds within it a rich history, tracing back to the Latin root "cred," meaning "to believe." This etymology is evident in a myriad of terms such as credence, credential, and creed, each embodying the notion of trust and belief. Yet, in modern finance, the term has evolved into a complex relationship between borrowers and lenders, encapsulating transactions, trust, and financial responsibility.
Let’s start with what is a credit score?
Credit signifies the agreement between a borrower and a lender, wherein the former receives funds with the commitment to repay them along with accrued interest at a later date. While this traditional understanding persists, contemporary society has broadened the scope of credit to encompass various financial instruments and services.
A credit score is a numerical representation of an individual's creditworthiness. Calculated based on an array of factors including credit history, debt levels, repayment patterns, and more, credit scores serve as a critical metric for lenders assessing risk. In Canada, Equifax and TransUnion stand as the authoritative bodies responsible for determining and managing these scores, which typically range between 300 and 900.
A good credit score is required in pivotal life events such as applying for a mortgage, buying a car or even when applying for a Line of Credit (LOC). Though standards can differ slightly among lenders and credit bureaus, in general, credit scores are ranked as follows:
- 300 to 574: Poor
- 575 to 659: Below Average
- 660 to 712: Fair
- 713-740: Good
- 741-900: Excellent
Achieving and maintaining a favorable credit score requires more than mere numerical attainment—it necessitates a holistic understanding of the underlying factors influencing one's creditworthiness. Enter the "5 Cs of Credit."
- The Capacity to pay (mental, physical, etc.)
- The Capital available unencumbered
- The Conditions in the market
- The Character of the person (or entity)
- The Collateral(s) available
Credit Score requirements for mortgages in 2024 are becoming tougher, but a credit score of 680 or above should be good to qualify for the best mortgage rates in Canada. When you are applying for a mortgage to buy a home, lenders will typically look at your credit history reports from the three major credit bureaus – Experian, Equifax, and TransUnion. In most cases, mortgage lenders will look at your FICO score.
What does FICO stand for? Fair Isaac Corporation - FICO is the acronym for Fair Isaac Corporation, as well as the name for the credit scoring model that Fair Isaac Corporation developed. A FICO credit score is a tool used by many lenders to determine if a person qualifies for a credit card, mortgage, or other loan.
Navigating the intricacies of credit management can be daunting, particularly for those new to the financial landscape or grappling with past financial challenges. However, there are actionable steps individuals can take to improve their credit standing over time.
First and foremost, maintaining a pristine payment history is paramount, constituting a significant portion of one's credit score. Timely payments not only demonstrate financial responsibility but also mitigate the risk perceived by lenders. Additionally, managing debt levels responsibly and maintaining a healthy credit utilization ratio—ideally below 30%—can positively impact one's creditworthiness.
Recognizing the importance of credit history length and exercising restraint in acquiring new credit accounts are integral to fostering a favorable credit profile. By adhering to these principles and cultivating sound financial habits, individuals can enhance their creditworthiness and unlock opportunities for financial prosperity.
