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Although many consumers aren’t totally clear on what a credit score really means, most are concerned about their credit rating when it comes to evaluating their financial health. Learn why your credit rating is often the wrong measure, how focusing on your credit rating can negatively impact your finances and what most Canadians should be working on instead to improve their money matters.

Vancouver Licensed Insolvency Trustee Blair Mantin often hears from consumers who know they have a debt problem and need help but are concerned about taking any step that might damage their credit rating. As Blair explains to Global News, most folks are putting their energy into the wrong focus – instead of trying to maintain a “perfect” credit score they should be aiming to become debt-free.

Watch the video clip here, and read more below:

Understanding Your Credit Score

What is a Credit Score?

Your credit score is a number ranging from a low of 300 to a high of 900, calculated based on the information your credit report contains. Your credit report is essentially a public record of your credit history including personal information – it will have details about your debts such as how long you’ve had an account, the balance and payment history.

  • Banks and other lenders will use your credit score alongside their individual borrowing policies to set interest rates and credit limits for their customers.
  • In Canada Equifax and TransUnion are the two major credit bureaus used by banks and lenders, and they may not show the same information.

How are My Credit Score and Report Updated?

Your credit report is generally updated when lenders (like your credit card company) report new balances or payments, but also when new accounts are opened, old ones cancelled, or if lenders have made an inquiry when you are seeking credit.

  • Generally consumers can expect that their credit score and report will be updated around once a month.
  • Your credit score will be recalculated as your credit report information is updated – the score gains points for ‘favourable’ actions that show lenders you can manage your credit well (i.e. making payments on time) and loses points for actions that demonstrate ‘difficulties’ (i.e. missing payments).

Curious about some of the ways your credit rating might be taking a hit that you might not be aware of? Learn about “5 Sneaky Credit Killers”

Why Your Credit Score is the Wrong Indicator of Your Financial Health

Your credit score is only giving a very small indication of your overall financial health and is simply one of several variables that a lender will look at when setting terms of your borrowing agreement.

Your credit score is largely driven by how profitable of a customer you have been for the banks over time – credit scores were originally designed as an internal measure that banks could use to determine which customers contributed to their bottom line.

The result of this is a paradox that what can be good for your cash-flow and budget can be “bad” for your credit score; and, what’s good for the bank and credit score aren’t necessarily good for your finances.

Here’s some factors to consider why your credit score shouldn’t keep you up at night.

Your credit score can be high even if…

  • You’re only making minimum payments
    • Keeping your account in good standing doesn’t necessarily indicate you have the money to pay it off within a short amount of time, it only shows that you’re servicing the interest per the lending terms and not letting the account fall delinquent.
    • Being able to make only minimum monthly payments (or slightly more than) is a big sign that your finances may be reaching a critical point, yet your credit score will likely show ‘perfect health’ if no minimum payments are missed.
  • You have no savings or assets that you could use to tide you over if your income was interrupted or if a financial emergency arose
  • You’re reaching a point of having over-extended yourself financially
    • Having the “right” amount of credit accounts to keep your score high doesn’t factor in a thing about your household budget and ability to pay your living costs without relying on credit to do so.
    • Up to 70% of people who make Consumer Proposals or even file for personal bankruptcy have an “ideal” credit rating at the time they file. It’s false that only people with bad credit scores file for bankruptcy or make Consumer Proposals.
      • It’s common for people to realize just how financially stretched they are when they apply to a bank for a consolidation loan and are refused additional credit because they are essentially maxed out; notwithstanding the strength of their credit rating.

Your credit score can be reduced by…

  • Making a large payment or closing an account
    • Simplifying your finances by reducing the credit you have or closing an account you don’t use much (or have paid off) can have a negative impact to your credit score because you’ll lose all the credit history associated with the account.
  • Having a high balance
    • Even if your credit limit is relatively low, carrying a balance of more than 50% of that limit can knock your score down regardless of your ability to pay it off in full.
  • Not having enough credit history
    • Less doesn’t necessarily equal more when it comes to credit accounts. Having only one credit card for example can make it difficult for a new lender to assess your lend-ability and therefore give you a lower score than someone juggling multiple accounts.

Your credit report can also contain mistakes and inaccuracies which can impact your score – it’s good practice to check reports from both credit bureaus annually, and follow-up on errors you may find. You can request copies for free once a year, there’s no need to sign up for any sort of membership or subscription!

Key Questions to Ask Before Consolidating Debt

Assess Your Debt Situation

Instead of relying on your credit score and history to gauge the state of your finances, here are some more accurate areas to consider when assessing your debts:

  • Savings

Do you have savings that can cushion your fall financially? The unexpected can (and often does) happen.  Consider whether your income and household expenses leave you room to set aside money for savings. What resources would you need to lean on in the event of a financial emergency? For many people juggling debt payments, the answer is often more debt.

  • Debt-Stress

How often do you find yourself thinking about your debts or worrying about money? Debt-stress is real stress and if you’re experiencing its symptoms it may be time to look into debt solutions. Constant worry, poor sleep patterns, feelings of hopelessness and impact to your overall well-being are just a few common signs you may be debt-stressed.

  • Time Required to Become Debt-Free

If your budget doesn’t allow you to make more than minimum payments, you’re consistently using credit to meet your costs of living, or you think it will take more than three years to become debt-free, you may want to consider debt consolidation options that can help you achieve those zero balances.

Licensed Insolvency Trustees are the only professionals that are endorsed and empowered by the federal government to help Canadians manage their debts. A free one-hour confidential debt consultation is offered by Licensed Insolvency Trustees and might be all you need to get a plan of action that will give you a financial fresh start.

Get started towards your debt-free future today. Book your free confidential debt consultation to meet with a caring, non-judgmental representative from Sands & Associates, BC’s largest firm of Licensed Insolvency Trustees focused exclusively on helping people become debt-free.