How to improve your credit scores

What is a credit score?

A credit score is a numerical rating that measures creditworthiness. Creditworthiness is the extent to which a person or company is considered suitable to receive financial credit, often based on their reliability in paying money back in the past.

There are two types of credit score:

1. Personal credit scores are usually a three-digit number between 300 and 900. They are used to assess the creditworthiness of individuals. They predict how likely a person is to repay borrowed money on time. A higher score indicates that a borrower is more likely to pay back on time.
2. Commercial credit scores are usually a three- to four-digit number ranging from 300 to 1400. They are used to assess the creditworthiness of businesses. More specifically, they are used to predict two credit events over the next 12 to 24 months:
   1. the likelihood that a business will be delinquent on paying its suppliers or loans
   2. the likelihood that a business will fail

A higher score indicates a lower probability of these events happening in the future.

Where do credit scores come from?

Credit scores come from credit bureaus. In Canada, there are two main credit bureaus:

• Equifax
• TransUnion

Each company has its own scores. Moreover, each company provides a number of different versions of their scores, both for individuals and businesses.

“Each score model has the same purpose: to predict the likelihood to pay on time,” says Julie Kuzmic, Senior Compliance Officer, Consumer Advocacy at Equifax Canada. “But some scores perform better to predict the repayment of specific obligations, like mobile phone bills or mortgage payments, so they can be used in different contexts.”

All consumer scores are calculated using the information available on the person’s credit report at the time the score is calculated. They differ in that they are calculated with algorithms that may weigh different factors slightly differently. These algorithms will typically have a name, like FICO 8 or FICO 10, in the case of FICO scores. Similarly, Equifax’s scores will be named ERS (for “Equifax Risk Score”) plus a number: ERS 2.0, ERS 3.0, etc.

What are the factors affecting credit score?

The factors affecting credit scores are different for individual and commercial credit scores. But they are all derived from analyses of the elements most predictive of a borrower’s solid repayment behaviour according to the information that has been reported to credit bureaus.

“On the consumer side, we look at depersonalized data based on Canadian credit reports, and we analyze which elements are statistically correlated with  timely repayment. We then use this knowledge to develop our algorithms,” explains Kuzmic.

Generally, the most predictive factors are past payment behaviours. Accordingly, they are typically weighted more heavily in the algorithms.

Main factors affecting your personal credit score

1. Payment history

This factor includes your history of on-time and late payments on all credit accounts which have been reported to the credit bureau. Late or missed paymentscan lower a credit score, while a record of consistent, on-time payments will generally strengthen it. More recent, bigger and more frequently missed payments can have a larger negative impact on the score.

2. Credit utilization

This factor is important for revolving accounts, like credit cards and lines of credit. The higher the account balance reported to the bureau  compared to your available credit limit, the more your score may be impacted, although the effect is not necessarily linear. According to Kuzmic, “credit utilization is a factor in credit score calculations because there is a statistical correlation between a higher utilization and people missing payments.”

3. Credit mix

This factor relates to the different types of credit accounts which have been reported to the credit bureau, such as credit cards, car loans and/or mortgages. If a person has a high number of credit accounts,–or doesn’t have a mix of different account types, their credit score could be negatively affected.

4. Length of credit history

This factor looks at the age of credit accounts: Borrowers with longer histories of responsible credit use will tend to have higher scores. A longer credit history can offer a more comprehensive view of someone’s borrowing and repayment habits.

5. Credit inquiries

A credit inquiry is a record that your credit report was accessed. Only those inquiries linked to applications for new credit (often called “hard inquiries”) can have an impact on your credit scores.

Too many hard credit inquiries in a short period of time can negatively affect your score. But not always. According to Kuzmic, it depends on the context. “If you apply for five credit cards in a short timeframe, your score will likely be impacted because you have now probably opened five new credit card accounts,” she explains. “But if you apply for five mortgages in a short timeframe, it’s probably just one shopping event: You are unlikely to be seeking five mortgage loans, based on standard consumer behaviour. So your score is less likely to be impacted.”

Main factors affecting commercial credit score

1. Payment history

As with individual credit scores, commercial credit scores tend to be positively impacted by timely payments or repayments of loans, suppliers, lines of credit and credit cards.

2. Length of credit history

Having a longer credit history and having been in business for longer will generally positively impact your company’s credit score.

3. Industry

Some industries are understood to be more risky than others, which can lower a business’ credit score.

4. Credit inquiries

Although credit inquiries are included in the calculation of commercial credit scores, they are generally weighted more lightly than on the personal side, explains Josh Farrington, Senior Commercial Consultant at Equifax Canada.

Is a credit report the same thing as a credit score?

A credit report is different from a credit score, explains Kuzmic.

“A credit report is a record of a person or company’s credit history maintained by a credit bureau,” she says. It contains information that has been reported to the credit bureau, such as:

• credit accounts
• payment history
• outstanding debt
• recent credit inquiries
• insolvency data

This information is collected from various sources.

On the individual side, these sources include:

• financial institutions and other creditors
• collection agencies
• the Office of the Superintendent of Bankruptcy (if an individual has ever gone insolvent)
• different courts of justice (if a person has unpaid income tax or family support, for example)

On the commercial side, these sources include among others:

• financial institutions
• suppliers
• the Office of the Superintendent of Bankruptcy
• the courts

Credit scores and credit reports are related, however, in that a credit score is calculated based on the information contained in the credit report.

Why are credit scores important?

Credit scores are important both for businesses and individuals because they can be a key factor in getting approved for a loan or other forms of credit.

On the personal side, having a good credit score is important because it can be one of the main factors financial institutions will look at when you apply for a loan, a credit card or a mortgage. “It is not the only one,” says Kuzmic. “They also look at employment status, income and bank account balances, for example. But the credit score is important.” Your personal credit score is a factor for many business loans as well.

Landlords may also use credit scores to assess potential tenants' reliability. Finally, in some lines of employment—especially in financial services—credit scores may be considered as part of the candidate vetting process, along with criminal records and previous job references.

On the commercial side, credit scores can also be crucial to access financing, explains Farrington. “But they can be important as well for car or equipment leasing, for example, because a company may look at your score before signing a deal.”

Where can you see your credit scores?

Individuals and businesses can check their credit scores directly with the two nationwide credit bureaus: Equifax and TransUnion. It can also be accessed through other third parties. And many banks offer this information to their consumer clients for free. It’s worth asking for.

Kuzmic says it’s a good idea to keep an eye on your credit reports and scores because it can help you detect potential financial and take action before further damage occurs. “You could see that there was a credit inquiry at a specific bank last month, even though you never go there. So what’s going on? This is the type of issue that a credit report can help you identify before it’s too late.”

What is a good credit score?

On the commercial side as well as on the personal side, there are a number of credit scoring models, or ways to calculate credit scores. And ultimately, it is up to a lender to determine what they consider to be a poor, acceptable or great score.

“This being said, on the personal side, a score of 750 or higher is generally considered to be very good by most lenders,” says Kuzmic. Below 670, individuals may be considered potentially high-risk subprime borrowers. These borrowers may therefore have a hard time qualifying for new credit with mainstream creditors.

On the commercial side, however, there is more variability from one scoring model to another, making it harder to say, as a general rule, what is a good score.

General personal credit score range from excellent to poor

How can you improve your credit scores?

Your credit scores are generally based on your past credit behaviour. As a result, there are many things you can focus on to possibly improve or maintain your credit scores going forward. Here are the most important ones.

1. Pay on time

This factor may be the most important. Consistent, on-time payments tend to help build and maintain solid credit scores. Consider using tools such as automatic bill payments or alerts if you struggle with on-time payments.

2. Keep your credit utilization rate low

Utilization refers to the account balance reported to the credit bureaus relative to the credit limit on the account. Which rate of credit usage should you avoid going over? It is often advised to keep your credit utilization rate at or below the 30-50% range for revolving accounts such as credit cards and lines of credit. In reality, the impact on your credit scores will vary depending on a host of related contextual factors, explains Kuzmic. “Nevertheless, lower is usually better,” she says. To lower your utilization rate, you may consider asking for a credit limit increase. However, this may affect other factors in a credit score calculation and is not guaranteed to increase scores.

3. Limit new credit applications

For certain credit products, like credit cards, more credit applications may lower your score. To maintain your credit scores, try to limit applying for new accounts and only apply for credit when necessary.

4. Maintain a solid credit history

You may wish to avoid closing old, paid-off accounts. Keeping these accounts open can help maintain a longer credit history, which can be a positive factor in credit scoring. “Remember, also, that your credit score may be on the lower side simply because you are young, or a newcomer to Canada, and have a short credit history,” reminds Kuzmic. “In this case, credit scores tend tod improve gradually as your on-time bill payments are reported to the credit bureaus, as long as you are not making late payments.”

5. Ask suppliers to report on you

On the commercial side, companies with good credit behaviours should ask their suppliers to report on them to credit bureaus, advises Farrington. “If a supplier grants your business a line of credit, ask them to report this information to credit bureaus. The positive payment behaviour can then be taken into account in your commercial credit score.”

Can your business decisions affect your personal credit scores?

Entrepreneurs need to be careful about the way they manage their borrowing because it can affect their personal credit scores, explains Farrington.

“If you give a personal guarantee on a business loan or a commercial lease, for example, your personal credit scores can take a hit if your business goes delinquent on them,” he illustrates.

Similarly, if you use your home equity or personal credit card to support your business, your repayment behaviour can impact your personal credit scores, Kuzmic explains. “On the other hand, if business owners don’t use their personal credit for their business, their company’s repayment behaviour would not impact their personal credit scores.”

Next step

Get insights into what lenders and banks look for when evaluating you for a business loan by downloading our free guide for entrepreneurs How to Get a Business Loan.