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A credit score is an extremely important number that can end up dictating many of the choices you make in life. Your credit score will ultimately determine how able you are to get loans, which in turn can alter your likelihood of being able to buy property, or being able to afford that new car.
It’s a little bit of a chicken and egg situation – the worse your credit score becomes, the harder time you having getting loans, the higher the interest rate on those loans which often results in more financial hardship – which in turn leads to a worse score!
It’s very important to keep your credit score as high and your report as pristine as possible, even when you’re not looking to get a mortgage or any sort of credit. Let’s take a look at how to improve credit scores in Canada.
1. Pay Down Debts
In order to improve your credit score, you need to pay down your outstanding debts so that you’re not utilizing more than 30% of the total credit you have available to you.
The reason for this is simple: if you’re using 95% of the credit available to you, creditors usually take this as a sign of you not having enough cash and are therefore relying very heavily on credit – if you had the cash you would pay the credit down.
Creditors want to see a good track record of you paying back money that you’ve borrowed in the past.
If you have ever failed to pay back loans, or if you have defaulted on your loans, chances are that other lenders won’t want to offer you credit at a reasonable interest rate.
Keeping your current credit obligations top of mind is important – don’t overextend yourself.
2. Consolidate Your Loans
But what happens if you don’t have enough money to pay down the credit you already have? What happens if you have many credit accounts, the majority with interest rates of 19.99% or even 22.99%?
One option would be to consolidate – taking out one larger loan, and then using that in order to pay off the other credit you owe.
While the specifics of a consolidation loan will vary depending on your situation, people usually:
- Roll all of their outstanding retail credit into the mortgage they currently have if there is enough equity in the home – This brings you down to an interest rate probably around 3% based on current market conditions and allows you to just make one payment. So a secured loan essentially.
- Some banks and lenders will offer unsecured loans roughly up to $50,000 – If you have many credit cards and small loans of $5,000 to $10,000, you can roll them all into this one larger credit facility – However, getting an unsecured loan for $50,000 means you already have pretty stellar credit and some cash in the bank
3. Get a Credit Card If You Don’t Have One
The correct usage of credit cards can be a great way to build credit history. Credit cards essentially mean you buy on credit and then pay back at a later date.
This has a ton of advantages as it makes it easier for you to manage your cash flow and it offers you added protection from bad actors when shopping online for example.
If you then bear in mind that credit histories are based on your past performance with loans, using a credit card essentially allows you to very quickly take out and pay off lots of those small loans to demonstrate your ability to make good on your commitments.
How to Build Credit With Your Card
The good news is that this is a straight forward process. Essentially, this will involve using the credit card for only small payments on a regular basis.
A great example is something like your morning coffees on the way to work, or gas for your car.
Your statement will close on X date and you will have a payment date of Y. Make sure you pay the FULL amount by the payment date of Y.
The important thing here is that you don’t get tempted to use the credit card to purchase things that you can’t afford.
If you do this, you will only find that you end up in more debt and this can actually be bad for your credit.
The whole point of using your credit card is to demonstrate your ability to use it and pay it off in full every cycle. This is the basic principle of credit.
An Added Tip!
If you find you do get into credit card debt , a quick tip is to try transferring your debt to a new card.
Many credit card companies offer 0% interest for the first 6-12 months, so this way you can avoid racking up 19.99% interest charges.
What you essentially do is called a balance transfer, a simple act of moving the balance from one credit card to the other.
However, ensure you know that you are either going to close the first credit card or not use it – the last thing you want is to now have 2 credit cards that are full.
4. Stay in the Black
Before purchasing something on credit besides a car or home, confirm that the cash is actually in your bank account and therefore you can afford it.
I’ve seen many cases where people don’t make the connection between their cash and their credit – they go off on shopping sprees and since cash is not actually exiting their pocket, it seems like it’s all good – until the credit card bill comes and you can’t pay it off in full.
Budgeting is the key here.
Understand what you can afford to spend each month. Using a credit card to purchase it should not be the deciding factor – the decision on your $300 a month shopping budget was already made long ago – paying for it with cash or credit is up to you.
5. Responsibly Open Credit Accounts
Interestingly, another way to improve your credit score in Canada, is to actually open up credit accounts.
Credit Utilization = Total Amount Due On Your Credit / Total Credit Available
28% = $2,240 / $8,000
Now if the bank offers you a pre-approved line of credit for $10,000 and you take it, your new credit utilization would be the following assuming your credit spending stays roughly the same:
12% = $2,240 / $18,000
Some may think it’s counterintuitive – why have all this credit if you’re not using it? Well you are using it, it’s just about time horizon.
- Credit Cards: Short term, month to month, use it every month and pay it in full when the bill comes
- Line of Credit: Short term, maybe carry a balance for a couple of months to cover a period of time where you had extra expenses and not enough cash flow
- Personal Loan/Auto Loan: Medium term, usually like 3 to 5 years with a fixed payment amount every month
- Mortgages: Long term, usually 20 to 25 years, fixed payment amount every month
The problems arise when you start treating credit cards and lines of credits as long term credit facilities.
They are meant to be used and paid in relatively short periods of time.
6. Change Your Mindset
Finally, if you really want to know how to improve your credit score in Canada, the answer is that you need to address your own mindset.
While there are plenty of strategies and methods you can use, all of them require a commitment on your part.
This is not a criticism, but rather an observation of human behaviour: people in debt that bury their heads in the sand and hope that things improve on their own do not get very far.
Ironically, the more in debt we are, the worse our financial decisions tend to be.
Many of us hold unhelpful beliefs about money which stem from our upbringing, and which can prevent us from improving our finances.
It’s important to address these yourself, and to come up with plans for how you are going to change your behaviours.
Ultimately, spending a little less on a latte every morning is unlikely to make a huge difference in your life.
But making the difficult decision not to go on holiday, or to stick with that older computer, really can.
And apart from those isolated decisions, it is the general mindset and approach to money that will help you to build healthier habits and get out of debt!
Eventually, you can develop a credit score that will give you access to whatever cashflow you need at great rates and life gets a whole lot less stressful once that happens!