What makes good credit good, and bad credit bad?
What makes good credit good, and bad credit bad?
In my 18 years of lending, I’ve heard so many common misconceptions about credit, especially with younger borrowers. I often hear from first-time buyers that they don’t think their credit is “very good,” but they can’t necessarily articulate why.
Having a better credit score undoubtedly affects your interest rate and ability to qualify; however, there are a lot of different factors that go into credit. The credit bureaus are simply impartial databases that track and store information and assign a score based on pre-determined formulas. Remember that the score is just that – a number – what’s more important is the story that your report tells. What are your patterns with credit? How do you manage it? How much (or how little) of it do you have?
Scores range anywhere from 300 to upwards of 900, with a minimum ‘good’ score sitting at 650 and going up from there, but like I said - it’s just a number.
For example, I’ve seen new-to-credit borrowers with one $1000 limit Hudson’s Bay card that’s been open for 6 months have a solid 725, and I’ve seen established borrowers with excellent repayment who for one reason or another may have a score in the 600s. It’s not a perfect formula, so my advice is to focus more on the contents of your report.
So what affects my score? Contrary to popular belief, having credit doesn’t negatively affect your credit – but how you use it does. A few situations that can put a damper on your score:
Keeping your credit cards at or near their limit – if your card limit is $5000 and you constantly sit at $4999 this will have an adverse effect on your score
Having too much open consumer credit – regardless of usage, having a wallet full of department store cards and Visas, MasterCard’s and Amex’s galore ups your total credit exposure and in turn your potential risk of getting in over your head
Having no open credit – having no active credit at all means there’s nothing to track, which makes it difficult for a score to be assigned or for a lender to analyze credit behaviours
The number one thing (IMO) that affects your credit is NOT MAKING PAYMENTS ON TIME - plain and simple. I’ve had borrowers who were never adequately advised tell me that they’re waiting on making the monthly payment until they save up more so they can submit a larger payment, which is a big no-no. A credit bureau reports repayment patterns and tracks how many times you’re late (30-60-90 day and beyond). If you’re habitually late making payments, then lenders see this as a BIG risk, so even if it’s only the minimum payment you can make, make it. Someone who makes their minimum payments consistently, even if they carry a balance, is likely to have a much better credit score then someone who pays late all the time but makes large payments when they do pay. In short, the credit report is more concerned with how you pay verses necessarily what you are paying.
One other thing to watch for is collection items. Yes, it probably is the case that you cancelled that gym membership, but they kept on billing, or perhaps that parking ticket you got was unjustified. These scenarios are very common, but ignoring collection items won’t make them go away. In fact, as long as they stay open, they stay on the bureau, so you’ll want to eat the frog and address any issues head-on. Once you come to a resolution with the creditor, they will update the status to PAID/SETTLED, and you can move on. The lender may ask for an explanation, and showing that you’ve faced up to any outstanding issues shows that you’re proactive and care about your credit.
Last but not least, don’t fear the consolidation loan. I’ve heard people say they don’t want to take this route as they’re worried it’ll hurt their credit, but this is not necessarily the case. If you have 3 credit cards sitting at their limit and you’re making interest-only payments at 20%, it’ll be tough to get ahead. If you approach your bank for a personal loan, you could significantly lower your rate and eliminate that debt faster – even if it means closing cards or reducing some of the card limits, it’ll benefit you in the long run.