13.6: Build a Good Credit Rating

If you can create a budget and stay on budget, that’s a good thing; however, as the saying goes, life happens, and you may find that your car breaks down when you least expect it, and the bill could be over $1000 — that may not have been in your budget. You may require a loan, so ensure you understand the different types of loans. You won’t get a bank loan unless you have a good credit rating. A good thing to do is to plan for crises and contingencies, which will help you mitigate these risks. It is always a good idea to have a special reserve of money, a “rainy day” fund, for emergencies or large expenditures you did not plan for.

The amount of money you should have in your emergency fund can vary depending on your personal and financial goals. As a rule of thumb, financial experts recommend having enough savings to cover three to six months’ worth of living expenses.^[1]

For now, you are probably thinking about credit cards more than anything else. They are a great way to establish your credit history so that you can apply and qualify for some of those other loans later. There are some important things about credit cards that you need to know, though, a big part of that has to do with the way that you use the credit card and how the banks interpret that use — it’s called utilization. Read “How Does the Credit Utilization Percentage Impact My Credit Score?” to learn more.

Do you often find yourself splurging or impulse shopping? Are your monthly bills more than you can comfortably afford? If you find yourself unable to make timely payments on loans or rent, you risk damaging your credit rating, which could affect your ability to borrow money in the future.

So, how do potential lenders determine if you are a good or bad credit risk? If your credit is poor, how might this affect your ability to secure a loan or the interest rates you’ll be offered? In Canada, a credit rating is a numerical score that reflects an individual’s or business’s creditworthiness, based on their financial behaviour and credit history. Every time you use a credit card or borrow money, such as from a bank, your spending and debt habits are recorded. This information is then used by lenders, such as banks and financial institutions, to assess the risk of lending money or extending credit. Credit ratings in Canada are typically provided by two main credit bureaus—Equifax Canada and TransUnion Canada.

While Canadian credit scores are similar to the U.S. FICO score, they are not exactly the same. Credit bureaus in Canada, like Equifax and TransUnion, use their own scoring models to assess creditworthiness. Canadian credit scores range from 300 to 900, with most individuals falling in the 600–700 range, which is considered a good score. Your score is influenced by factors such as payment history, debt-to-income ratio, length of credit history, and the types of credit accounts you have. While Canadians may not use FICO scores, the concept is similar: both systems assess an individual’s ability to repay debt and manage credit responsibly. You can access your Equifax score for free online or by mail, and residents of Quebec can access their TransUnion score for free. Some banks also provide free credit scores through online banking services. Ultimately, your credit score plays a key role in determining whether you qualify for credit and the interest rates you’ll pay.

A credit score is calculated by considering five main criteria:

• Payment history
• Use of available credit
• Length of credit history
• Number of inquiries
• Types of credit accounts

This score, along with other credit history information, is shared by the credit bureaus with their subscribers, helping lenders assess credit risk when considering loan applications.^[2]

So, what does this mean for you? It depends on your credit behaviour. If you pay your bills on time and don’t take on excessive debt, you’re likely to have a high credit score, which will make you more attractive to lenders. This could result in receiving loans with reasonable interest rates. However, if your credit score is low, lenders may be hesitant to approve your loan applications, or they might offer loans at higher interest rates. A low credit score can even impact your ability to rent an apartment or secure certain jobs. That’s why it’s crucial to do everything you can to maintain a strong credit score.

Credit Score Ranges and What They Mean 

Although the exact credit score ranges may vary slightly depending on the credit bureau or scoring agency, understanding where your credit score falls is essential for assessing your financial health. Knowing your score will help you understand what actions you may need to take to improve your creditworthiness and achieve your financial goals.

Here’s a breakdown of typical Canadian credit score ranges and their implications:

• Poor (300 to 559): If your score falls in this range, you may be considered a higher credit risk. You might find it difficult to obtain loans or credit cards, and if approved, you could face higher interest rates or less favourable terms.
• Fair (560 to 659): With a score in this range, some lenders may still see you as a higher-risk borrower. You may have access to credit, but at higher interest rates and less favourable terms.
• Good (660 to 749): A good credit score indicates you are a reliable borrower and can likely qualify for many loans and credit cards with reasonable terms and rates.
• Very Good (750 to 849): At this level, you are seen as a low-risk borrower, which means you are likely to qualify for the best loan terms, lower interest rates, and higher credit limits.
• Excellent (850 and above): If your score is in this range, you’re considered an exceptional borrower, which typically means the best possible loan terms, lowest interest rates, and higher credit limits are available to you.

As a young person, building a strong credit history that will lead to a higher credit score can be achieved with a few key steps:

• Become an authorized user on a parent’s credit account.
• Obtain your own credit card, but don’t apply for several credit cards at the same time.
• Choose the right credit card for your needs.
• Use the credit card for small, regular purchases, but avoid large purchases unless necessary.
• Pay off your balance in full each month to avoid interest.
• Pay all your bills on time.
• Avoid cosigning loans for others or applying for multiple credit cards at once.
• Use student loans for education expenses only, and always make your payments on time.

If you qualify for your own credit card, aim for one with a low interest rate and no annual fee to build your credit responsibly.

Secured Versus Unsecured Credit

Credit Cards

Credit cards can be secured or unsecured. Unsecured credit cards don’t require a deposit and offer a credit limit based on your creditworthiness, such as your credit score and income. If you carry a balance, you’ll be charged interest, typically between 15% to 25% APR. The interest compounds, meaning you’ll pay interest on both the principal and any accumulated interest if the balance isn’t paid off in full each month. Secured credit cards, on the other hand, require a deposit that acts as collateral for your credit limit. These are often used by people building or rebuilding credit and may have similar interest rates to unsecured cards, but carry less risk for the issuer.

Your credit card usage directly impacts your credit score, particularly through factors like credit utilization (the percentage of your limit used) and payment history. Many cards offer rewards such as cashback, points, or miles, along with benefits like purchase protection or travel insurance. However, credit cards can also come with fees, including annual fees, late payment fees, or foreign transaction fees. By managing your credit card well—paying on time, keeping balances low, and avoiding high-interest debt—you can build a strong credit history and minimize interest charges.

Bank Loans

Bank loans come in both secured and unsecured varieties, and the type of loan you choose impacts factors like interest rates, required collateral, and the potential for compound interest.

• Secured loans require you to provide collateral—something of value, such as a house (for a mortgage) or a car (for an auto loan). This collateral reduces the risk for the lender, which typically results in lower interest rates compared to unsecured loans. The interest rates for secured loans can vary widely based on factors like the type of loan, your creditworthiness, and the collateral involved, but they are generally more favourable than unsecured loans. For example, mortgage rates might range from 3% to 7%, while auto loan rates might be in the 4% to 10% range. In a secured loan, if you fail to repay, the lender has the right to seize the collateral.
• Unsecured loans, on the other hand, do not require collateral. Because there is no asset backing the loan, these loans are considered higher risk for the lender, which typically results in higher interest rates. Unsecured loans, such as personal loans or credit card debt, often come with interest rates ranging from 10% to 30%, depending on your credit score and financial history. Compound interest applies to unsecured loans as well, meaning the interest is calculated not only on the original amount borrowed but also on any interest that has accrued. This can cause the debt to grow quickly if not managed carefully, particularly if only minimum payments are made.

In both types of loans, interest is generally calculated as simple interest for personal loans, mortgages, and auto loans, meaning the interest is only charged on the initial loan amount. However, with credit cards and some other types of revolving credit, compound interest is used, leading to interest on both the principal and any accrued interest. To minimize the impact of interest, it’s important to understand the loan terms, make timely payments, and pay more than the minimum required whenever possible. For both secured and unsecured loans, maintaining a strong credit score can help you secure better interest rates and more favourable loan terms.

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