How is a Personal Credit Rating Calculated?
If you have ever applied for a loan, you will have come across the concept of a credit rating.
Lenders use it to decide whether they want to give you money or not – but what is it, exactly?
In Canada, a personal credit rating is a numerical measure of your financial trustworthiness.
It is a tool that creditors use to assess the likelihood that you will pay them back according to the terms of your lending agreement.
In short, it provides them with a quick metric of how likely you are to make repayments on time and repay the debt.
Need Help Reviewing Your Financial Situation?
Contact a Licensed Trustee for a Free Debt Relief Evaluation
How Personal Credit Ratings Work In Canada
In the distant past, creditors didn’t have any easy tools that they could use to assess the creditworthiness of borrowers.
For that reason, they would sleuth around, collecting information about applicants from friends and family about their financial position.
Today, things are a little different.
If you apply for a credit card or take out a car loan, the lender won’t start calling everyone you know.
Instead, they will use your credit report – a summary of relevant financial events in your life, telling them the likelihood that you will pay them back.
Importantly, creditors don’t collate these reports individually.
Instead, everybody who officially lends money agrees to send your data to a credit rating agency.
These institutions then use this information to construct a detailed record of your borrowing and repayment history.
At the end of the process, they assign you a number corresponding to the risk you present.
The more likely you are to repay money you borrow, the higher your rating.
In Canada, there are two credit rating agencies: TransUnion and Equifax.
Any major institution that offers credit or related products will pass on your information to these two agencies.
This includes all banks, credit card providers, personal loan companies, and finance organizations.
Your data, however, remains protected.
Equifax and TransUnion must follow specific rules when sharing your information with lenders and creditors.
Furthermore, nobody is allowed to view your credit score without your permission.
Creditors, therefore, must ask first before they can see your report and decide whether to lend to you.
What Activities Does A Personal Credit Rating In Canada Capture?
Credit rating agencies collect all kinds of financial information about you that might indicate your capacity to repay loans in the future.
Sources of information include things like mortgages (on some reports), credit card habits, store card information, overdrafts and lines of credit, and any overdue debts in collection.
These details flesh out your credit report.
Taken together, your credit report and credit score comprise your credit rating.
How Do Credit Rating Agencies Determine Your Score
Both TransUnion and Equifax use credit scores that run on a scale from 300 to 850 or 900 (depending on which performs the calculation).
Interestingly, they base the rating on statistical modelling of the likelihood that you will repay any money lent to you.
For instance, if a person has a credit score of 350, it means that roughly 350 people out of 850 with that score will repay their loans in 12 to 24 months.
Ratings, therefore, give lenders a quick way of determining whether somebody will repay them, and the level of risk they present.
In Canada, lenders adjust their interest rates based on the riskiness of a borrower’s credit score.
Those with low ratings typically pay higher interest rates, while the reverse is true for those with higher scores.
In some cases, lenders will deny people with low credit scores access to loans altogether.
It is just too risky for them to lend at any rate of interest.
Credit rating reports have broader implications than many people realize.
While they are vital for obtaining a loan, they can also impact other aspects of life.
Employers, for instance, may demand that you present them with your credit history so that they can get a better assessment of your character.
Landlords may also request access to your credit report as evidence that you are likely to pay them consistency over the life of the tenancy.
If you have money problems or have been through bankruptcy, you can struggle to get the finance that you need.
Understanding how to improve your credit report is, therefore, vital.
Debt counsellors and bankruptcy experts can take you through the process of getting out of debt and putting your credit rating back on the path to recovery.