What is Credit and How Does It Work?

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You can achieve financial wellness by understanding credit and how your financial habits affect your credit rating. For the majority, using credit is an unavoidable rite of passage; you may need credit to purchase a home (mortgage) or even a car.

What is Credit?

Simply put, credit is the ability to borrow money with the promise to pay at a later date. From the moment you turn 18, you can start building a credit history based on your borrowing habits. Your credit history reflects your financial reputation. Financial institutions, lenders, and other businesses use credit to predict what you might do in the future by looking at what you have done in the past. Having a strong financial reputation means you have good credit.

Good credit is necessary to borrow money for large purchases, like a mortgage or renovations. Knowing how to use credit responsibly has many advantages; it is a major deciding factor on the amount you can borrow and the interest you will have to pay. Lenders look at your credit history to decide if they will lend to you and to establish the terms of that agreement.

What is a credit rating and why does it matter?

Your credit rating, a measure of your financial well-being, is determined by two things:

  1. Your credit report: a collection of all your financial activities from various lenders
  2. Your credit score: a 3-digit number between 300 and 900 that measures your creditworthiness and is determined by grading your financial activities. The higher the number, the better the score.

There are two institutions collecting credit information on Canadians: Equifax and TransUnion. These agencies use this data to create your credit report and determine your credit score. In Canada, any promise to pay will be reported to a credit bureau.

Lenders may request your credit report to verify your borrowing history. However, lenders are not the only ones interested in your credit rating. Insurance companies, prospective employers, and even landlords can use your credit score to determine whether or not they will conduct business with you.

A good rating can make life a little easier. In addition to helping you access loans and earn low-interest rates, good credit enables you to make progress on your financial goals.

How to improve your credit rating?

While getting out of a low rating may take time and consistent effort, these five things will immediately put you in the right direction.

1. Pay on time, all the time

Late payments harm your credit score. While a few late payments may not affect your score, multiple late payments definitely will. For a potential lender, paying on time is a major pointer that you will meet your financial obligations.

2. Don’t be a credit seeker

Each time you apply for credit from a lending institution, the institution pulls your credit report. Some of these inquiries will negatively impact your credit score, especially if there are multiple requests within a short time. To improve your credit rating, try not to apply for credit often

3. Maintain a low credit utilization ratio

Only use a small percentage of the credit available to you. A good rule of thumb is to keep your used credit amount under 35%. That means, if your credit card limit is $10,000, use only $3,500 and pay it off in full each month. From a lender’s perspective, using all the credit available to you makes you a high-risk borrower.

4. Increase the length of your credit history

While having a low credit score is considered risky, having no credit history at all is almost as bad. So start building your credit history as soon as you can. You can do so by applying for a low-balance credit card, using it, and paying it off in full each month. Your credit history stays on your report for seven years. After seven years, you get a clean slate. The longer you can prove that you have good financial habits, the better it is for your credit rating.

5. Use different types of credit

Having different types of credit and using all of them responsibly will positively impact your rating. Variety demonstrates your ability to handle different types of credit. Some examples of diverse credit types include a line of credit, a credit card, and a car loan.

How can Cambrian help you use credit responsibly?

At Cambrian, our members are our priority. We want to support our members’ financial well-being by ensuring that they are well informed and aware of the best financial practices.

We offer members financial guidance to improve their credit, life stage planning, cash-secured loans, and member overdraft protection. You can book an appointment with an advisor on our website – they’re happy to find the banking solutions that are right for you.