Do you know how your credit score is calculated? Not many people do because the exact math behind it is kept hidden from the public, but there are many things we do know about how your credit score works and what you can do to improve your rating.
Today I’m going to give you an overview of myths and facts about your credit score and some tips on how you can improve your credit rating, which in turn leads to better mortgage rates when you want to purchase a home.
Myth #1: Having Too Many Credit Cards Hurts Your Credit Score
This is false.
Lenders want to see that you have trade lines (credit cards, loans, etc) and that you have consistently been making payments on them. It demonstrates your ability to pay your commitments, which is a huge deal to somebody who is potentially lending you half a million dollars or more.
That being said, something to be aware of is your credit utilization. That is how much of your available credit are you actually using, and the sweet spot is 70%. So if you have a credit card with a limit of $10,000, the lenders want to see you keeping the balance under $7,000.
The reality is that you could have 8 credit cards, and as long as you are making payments on time and keeping your credit utilization below 70% then it doesn’t matter that you have that many.
In fact, it can actually hurt you if you only have one trade line because that isn’t enough data to demonstrate your ability to pay. So most lenders want to see a minimum of two trade lines on your credit report, both in good standing.
Myth #2: You Won’t Improve Your Credit Score If You Don’t Use Your Credit Cards
This is false.
The lenders care more about managing your credit than whether you actually use it. This is why savvy parents get their children to open credit cards as soon as they are able but then tell them to never use them.
You let the card just sit there reporting how awesome you are at making your $0 payments. Even having $0 payments every month is better than having no payments every month. It adds up fairly quickly.
I recently had a client like this who had 2 credit cards since he turned 19, but never used them after activating them. On his 25th birthday he reached out to me to inquire about a mortgage but was worried about his score – his Equifax beacon was over 850 which was fantastic! And that was all because he had 2 credit cards that he simply never used, they just built up his financial reputation for him.
Myth #3: Paying Utilities Builds Credit Score
This is false.
In Canada, utility and telecom companies (i.e. mobile carriers) only report that you have an account with them, but they only report on the status if you don’t make payments.
So always making your cell phone bills will not improve your credit rating.
However on the flip side, if you fail to make your cell phone bills it will hurt you very quickly. I had a client a while ago who didn’t pay a bill with a major carrier and when I ran their bureau they had an R9 record from the telecom company (which basically means they are telling the world not to lend money to this person!).
Myth #4: Credit Checks Hurt Credit Score
True and false.
To understand this one you need to understand the different types of credit checks – hard and soft.
Soft credit checks occur when you check your own score (usually through an app or banking service). A soft credit check has zero impact on your credit rating. Some types of applications you submit for financial services will also be a soft check. Hard credit checks occur when you are applying for a financial product (credit card, loan, mortgage, etc).
It’s common for companies where you have a trade line open with them (i.e. banks, mobile carriers, etc) to run soft checks on your occasionally, usually as part of deciding whether to offer you some new promotions.
Hard credit checks on the other hand are done when you are applying for a financial product (credit card, loan, line of credit, mortgage, etc). A hard credit check has a small impact on your credit rating (usually 4-5 points), however each successive hard check within a short time span (usually 30 days) results in each additional credit check to hurt your rating substantially more.
Let’s say Bob is shopping around for a mortgage.
He talks to his bank and they run a hard check, which knocks him down 4 points.
A few days later he goes and talks to another bank and they run a hard check, this time it costs him 10 points because it was within a short time period of the last hard check.
Lastly, Bob then goes and talks to a licensed mortgage broker who also does a hard check, and this knocks him down a whopping 40 points because he had 2 hard checks recently before that one.
Without realizing it, Bob’s “shopping the market” cost him 59 points on his credit rating!
For this reason it’s strongly recommended to avoid shopping around in this manner. There is no harm in talking to multiple lenders, but you don’t want them all running your credit bureau in a short time.
Your better option is to use a service which soft checks your credit for you so you know your rating and you can tell the potential lenders your score. Once you have settled on a lender, then let them run the hard check (resulting in a single hard check instead of 3 like Bob did above).
However, as always I strongly recommend talking to a licensed mortgage broker for all of your mortgage needs. We have a much larger selection of mortgage products than the banks and credit unions do (we have access to the exact same mortgage the bank up the road is offering, plus every other bank, credit union, MIC, and private lender across the country!