Credit Score 101 for Adventurers and Other Miscreants

Urmi in HomeBuying, Money

For the longest time, I put off one of the first steps any potential HomeBuyer is advised to take: get one with your credit score or rating.  For most of my adult life, I’ve worried about the right shots to get when one is to live in a tropical urban jungle and what to read once one gets there.  I didn’t know much about Beacon or FICO scores, and what I dimly knew conjured up nightmares about being publicly inducted into some Credit Card Hall of Shame. Who hasn’t raided the sunscreen aisle of Shoppers Drug Mart at 3am, plastic money gripped firmly in hand, en route to yet another misguided “field research” trip?

For those who have returned home, and would perhaps like to stay (for now), here are some pointers on how cleaning up your credit score can help you on your way to HomeOwnership.  Your credit score is calculated by credit reporting agencies like Equifax or Transunion that get information about your credit behaviour from banks and collections agencies.  This information is what cell phone and other service providers look at when they run a credit check on you.  A mortgage broker will also look at your credit score, along with other information, to decide on how much to lend you as a HomeBuyer.

No matter how nervous you feel, remember G.I. Joe’s old missive: knowing is half the battle.  Figure out where you stand right now.  Checking out your score a year or two before you plan to become a HomeBuyer gives you time to get into better financial shape before you apply for a mortgage.  You can purchase a copy of your credit score or report online at www.equifax.ca or www.transunion.ca (visit our HomeBuyers Guide to learn why it is best to buy a full copy of your credit report). 

Your credit score is calculated according to your credit card, student loan and  other credit history.  Some factors that affect your score include your debt-to-credit ratio, the number of missed or late payments you have accumulated, and the number of accounts or loans that you’ve had sent to collection agencies.  Read your report and the accompanying guidelines carefully to understand what your score means.  (Is it high or low?  What are the trouble spots?)  You can also learn how to dispute information you believe to be in error.  (Note: the purchase of any Original Hits! K-tel music recording is an error of another kind.)

Getting your debt-to-credit ratio down is one of the most effective things you can do to improve your score.  For credit cards, you can get a rough idea about what your ratio might look like by totaling all of the money you owe on each of your credit cards and comparing it to the number you get when you total the limits on all of your cards.  So, if you have two cards, one with a limit of $2,000 and one with a limit of $1,000, your total credit is $3,000.  If you owe $150 on each, your debt is $300.  Your debt-to-credit ratio is calculated by dividing your total debt by your total credit ($300/$3,000) which would give you a ratio of 10% in this scenario—not bad.  Of course, reducing your debt makes your ratio that much better. When it comes to assessing other credit activity, like your student loan, banks generally look at how much you still have to pay back compared to how much you were initially given—so the more you pay back, the better your ratio gets.

If your overall ratio is too high, can you get on better footing?  Yes, but you need to take action now.  One of the most powerful but challenging ways to improve your score is to reduce your debt.  Each month, pay more than the minimum owed on the card or loan on which you are charged the highest interest, making sure to keep up minimum payments on the others.  Generally, this means that your plan will be to pay off your credit cards first, before moving on to tackle your other loans.  You will need to be patient as it may take months or even years to meet your goals.  Get creative to stay motivated.  Try hanging up pictures of your dream home or hut to spur you on.  When the yellowed edges start to curl, read Orwell’s Down and Out in Paris and London for more practical commiseration.

Reducing debt easier said than done?  For more detailed strategies, here is a suggested booklist to get you started (warning—frenzied cover graphics ahead, store in linen closet):

  • Start Late, Finish Rich by David Bach—Canadian edition (this expert coined the term “latte factor” to show how small savings can add up to financial recovery)
  • Young, Broke and Fabulous by Suze Orman (folksy but sharp advice from a US media personality with well-tailored financial strategies for those aged 20-35)
  • Managing Debt for Dummies by John Ventura and Mary Reed (the basics from a straight-forward series)
  • Debt-free by 30: Practical Advice for Young, Broke, and Upwardly Mobile by Jason Anthony and Karl Cluck (good financial tips to manage a modern lifestyle)
  • Taming Personal Debt by Paul Sampson (good section on debt incurred by small business owners)

(Now for the all-the-way-at-the-bottom print: all of the examples I’ve given are just that, examples, and rough ones at that; you should always consult with a certified financial planner (CFP) or a credit reporting agency to discuss your personal situation in detail.)

Urmi Desai is a freelance writer and editor of the Move Smartly blog.

Buying     |     Market     |     Mortgage     |    

Toronto’s most authoritative real estate insights, delivered right to your inbox.