All About Credit Scores

“Doesn’t that ruin your credit?”

No doubt, it’s a lot of fun to travel the world on Miles & Points, sometimes in the upper echelons of luxury and always for pennies on the dollar.

But when you tell your friends and family that your glamorous travels are funded with credit card points, how many of them react with such incredulity?

It’s one of the biggest and most common myths in personal finance that signing up for lots of credit cards necessarily hurts your credit score.

In reality, there are several nuances about credit scores and credit in general, which determine whether the effect of opening new accounts on your score is positive or negative.

Don’t forget that credit card signup bonuses are by far the best way to earn lots of rewards points, so if you take the time to develop even a high-level grasp of how your credit score works, you’ll be well-equipped to apply for the best cards, grab the signup bonuses, and be on your way to maximizing your travel.

The Basics of Credit

Let’s start with some terminology. There are two credit bureaus in Canada: Equifax and TransUnion. Both companies keep records of personal consumer credit activity in Canada. Whenever you open a credit account (like a credit card, mortgage, or loan), the credit-issuing institution reports your credit activity to Equifax and TransUnion.

And whenever you apply for new credit, the potential issuer “checks in” with one or both of the credit bureaus to look at your credit information and payment history, so that it can assess your creditworthiness. This is known as a credit inquiry.

The credit bureaus keep track of all of your credit accounts and their details (such as opening date, credit limit, and payment history), as well as all of the credit inquiries they’ve received to your file. This is known as your credit report.

In addition, Equifax and TransUnion both use proprietary formulas to calculate a credit score. The score ranges between 300 and 900. Since they’re calculated differently, don’t be alarmed if your Equifax and TransUnion scores are different.

Both credit agencies offer monthly subscription services that allow you to monitor all of your personal credit information, as well as your credit score, though it’s almost never worth paying for these, since there are many alternatives available…

Checking Your Credit Score

CreditKarma, the American credit-monitoring giant, has recently arrived in Canada and offer an excellent service that allows you to see your TransUnion credit score and report for free.

Best of all, CreditKarma’s view into your credit report is updated weekly, allowing you to monitor your overall credit health quite reliably. It’s by far the best service that I’d recommend for the purpose of staying on top of your credit.

Quite a few similar services have popped up in recent years as well, including Borrowell (Equifax, updated quarterly), Mogo (Equifax, updated monthly), and Ratehub (Equifax, one-time only). The CIBC and RBC mobile banking apps have recently introduced a feature to monitor your Equifax score as well.

There are even ways to order the information from Equifax and TransUnion directly without having to pay a monthly subscription. Equifax offers a free one-month trial period for their credit monitoring service, which can be used once every six months. Just be sure to cancel before 30 days have passed since you first sign up.

Meanwhile, TransUnion charges $16.95/month for their service, but Great Canadian Rebates is currently offering a $27 rebate for signing up. This means that you can pocket $10 just for checking your credit, providing you cancel the service before the first month is up!

How Is Your Credit Score Calculated?

The source of many people’s misconceptions regarding credit scores is a very simplistic view of how the score is calculated. It’s tempting to buy into the belief that “paying off your balances = good” and “applying for lots of credit = bad”.

As with many things in life, it’s not so black and white. Consider what generally goes into the calculation of Canadian credit scores:

• Payment history makes up 35% of your score

• Amounts owed and credit utilization make up 30% of your score

• Length of credit history makes up 15% of your score

• New credit applications make up 10% of your score

• Credit types make up 10% of your score

Payment history is straightforward. As a card-crunching points traveller, you should always be making your payments on time, so this portion of your credit score should be 100% positive.

Utilization refers to what percentage of your available credit is actually being used – think about the closing balances on your credit cards relative to your credit limits, both in terms of individual cards and across all your credit cards. Generally, issuers want to see 5–10% utilization as a representation of ideal credit usage.

If you’re close to maxing out all your credit cards, that’s obviously a bad sign. Meanwhile, 0% utilization can also count against you, since it portrays a lack of credit activity – issuers want to see that you are demonstrating the ability to use credit responsibly, and $0 balances don’t indicate that.

The other three factors are also pretty straightforward: a longer credit history generally helps, a slew of recent credit inquiries generally hinders, and a more diversified credit portfolio (across products like credit cards, phone plans, lines of credit, mortgage, etc.) is usually looked up on favourably as an indicator of good credit management.

The important thing to note is the different weightings that are given to each factor. To address all your friends’ concerns, applying for a dozen new credit cards in one year might have a damaging effect on 10% of your score, but if you manage those new cards responsibly and keep your utilization within reasonable bounds, that’ll drastically help the 65% of your total score relating to payment history and utilization!

It’s therefore entirely possible (and quite likely, if you do things right) that your credit score will actually increase alongside your points balances. How’s that for a slick deal?

Now, before you get too hung up on that three-digit number that Equifax or TransUnion spits out, just remember one thing…

It Doesn’t Matter!

That’s right. For the purposes of chasing credit card welcome bonuses, your credit score itself doesn’t really matter. At least not the ones calculated by Equifax or TransUnion.

That’s because when you apply for a credit card, the issuer assesses your creditworthiness on the basis of your overall credit report. In fact, many issuers apply their own proprietary calculations – distinct from the credit bureaus’ – when looking at your payment history, utilization, etc. in order to determine whether or not to approve you for a new card.

So rather than worrying about your credit score as it looks on CreditKarma, you should focus on employing sustainable, long-term strategies to improve your credit, keep it in tip-top shape, and maximize your chances of getting your next credit card application approved. These include:

• Make all payments on time: This is a no-brainer. Always pay your balance in full prior to the due date; that’s the only way to come out ahead in this game.

• Maintain 5–10% utilization, and definitely below 30%: If you’ve made a huge purchase this month and you’re running up to your credit limit, pre-pay the balance prior to the statement date to bring your utilization back down. Conversely, try to spend a small amount every now and then on cards you rarely use in order to generate “activity” on these cards and demonstrate responsible credit usage.

• Know which issuers “pull” your credit from which bureau: Not all issuers will send a credit inquiry to both Equifax and TransUnion when you apply for new credit. Chase Canada, for example, sticks to Equifax only, while American Express and MBNA generally pull from TransUnion. Knowing this can help you time your applications to maximize chances of success.

• Don’t cancel your oldest credit cards: These cards make up a big chunk of your “average age of accounts”, which is factored in to your overall creditworthiness. Leave your oldest credit accounts open forever! If you have to cancel to avoid annual fees, downgrade your card to a no-fee product instead.

• Give it time: 10% of your overall credit health is determined by the length of your credit history. You might get a few declined applications when you first start applying for cards, but over the years, if you play your cards right (pun intended), you’ll be well on your way to seeing that lovely approval message every time there’s another big welcome bonus on the horizon!

Do all of this, and every time you apply for a new card, you’ll be presenting the issuer with a clean bill of health. No matter how they slice it with their fancy formulas and mysterious metrics, they won’t have a reason to deny you those sweet sweet rewards!

Conclusion

There’s so many myths and misconceptions surrounding credit scores and credit in general, and it’s also one of the most common questions I get from those new to the game. Rest assured that if you take the time to grasp how credit reporting works, you’ll be well on your way to maintaining a credit score in the 700–800 range, all the while being able to rack up even more rewards points to fund your travels.