If you've ever applied for a credit card, a loan, or even a mortgage, you’ve likely heard the term “credit score.” But what is it exactly, and how does it affect your financial life? Whether you're a newcomer to Canada or simply want a clearer understanding of how credit scores work, this article will break it down for you in plain English.

We’ll cover how credit scores are calculated, why they’re important, and most importantly, how you can improve your credit score. Understanding credit scores is the first step in taking control of your finances and building a solid financial future.

What Is a Credit Score?

At its core, a credit score is a three-digit number that indicates how likely you are to repay borrowed money. This number helps lenders, landlords, and even some employers assess the level of risk involved in lending you money or offering you credit. The higher your score, the more trustworthy you appear to be as a borrower, and the better terms (like lower interest rates) you may receive.

In Canada, credit scores typically range from 300 to 900, with higher numbers indicating a better credit profile. Your credit score can affect almost every part of your financial life, from applying for credit cards to securing a mortgage, and even renting a home.

How Is Your Credit Score Calculated?

In Canada, there are two major credit bureaus: Equifax and TransUnion. Both agencies track your credit history and provide a credit score based on the information in your credit report. Although each bureau has its own scoring model, they both generally follow the same guidelines for calculating credit scores.

Credit scores are based on five key factors:

1. Payment History (35%)

The most important factor, making up 35% of your score, is your payment history. This is a record of how reliably you’ve paid your bills in the past. Missed payments, defaults, and collections will harm your score, while on-time payments will boost it. The more recent the missed payments, the more damaging they are to your score.

If you missed a credit card payment in the last three months, it could cause a noticeable dip in your credit score.

2. Credit Utilization (30%)

This factor looks at the ratio of your credit card balances compared to your total available credit. It’s expressed as a percentage, and the lower the percentage, the better. A high credit utilization ratio (i.e., using a lot of your available credit) signals that you might be relying too heavily on credit and could be at risk of not being able to repay your debts.

If you have a credit card limit of $5,000 and you owe $4,000, your credit utilization rate is 80%. This will negatively impact your credit score.

3. Length of Credit History (15%)

The longer you’ve been using credit, the better it looks to lenders. This factor is based on the average age of your credit accounts. A long and positive credit history shows that you have experience managing credit responsibly.

If your first credit card was opened five years ago and you haven’t missed any payments, this will help your score.

4. Types of Credit Used (10%)

Having a mix of different types of credit (e.g., credit cards, installment loans, mortgages, and lines of credit) can help improve your score. Lenders like to see that you can manage different kinds of debt. However, applying for too many new credit accounts in a short period of time can harm your score.

If you have a credit card, a car loan, and a student loan, you have a healthy mix of credit types.

5. New Credit Inquiries (10%)

When you apply for a new credit card, loan, or mortgage, the lender will conduct a hard inquiry on your credit report. Too many hard inquiries within a short period can signal that you're taking on too much debt, which can lower your score. However, one or two inquiries typically won't cause significant damage.

If you apply for three different credit cards in a short time frame, your score may drop due to multiple hard inquiries.

What is Considered a Good Credit Score in Canada?

Credit scores in Canada typically fall within the following ranges:

300–559: Poor

A score in this range suggests serious financial challenges, such as frequent missed payments or defaults. Lenders may be reluctant to approve your credit applications, and if they do, you will likely face very high interest rates.

560–659: Fair

A fair credit score shows that you’ve made some mistakes, but you’re working on improving your credit. While you may qualify for some credit, your interest rates will likely be higher than those with better scores.

660–724: Good

A good score indicates that you’ve been managing your credit responsibly. You will have access to loans and credit cards at reasonable interest rates, although some of the best rates might still be out of reach.

725–759: Very Good

A very good score means that you have a strong credit history and are likely to be approved for credit at favorable terms. Lenders will view you as a low-risk borrower.

760–900: Excellent

A score in this range means you’ve demonstrated impeccable credit behavior. You’ll qualify for the best interest rates and most favorable loan terms.

Why is Your Credit Score Important?

Your credit score is important because it affects your ability to access credit and the terms you receive. Here’s how it impacts different areas of your financial life:

Loan Approval

Lenders use your credit score to determine if they’ll approve your loan or credit card application. A low score may result in a rejection, while a higher score increases your chances of approval.

Interest Rates

Your score directly affects the interest rates you’re offered. The better your score, the lower your interest rate. A lower interest rate can save you hundreds or even thousands of dollars over the life of a loan or mortgage.

Renting an Apartment

Landlords often check your credit score as part of the rental application process. A low score may make it harder to rent, or you may be required to pay a higher security deposit.

Insurance Premiums

In some provinces in Canada, insurers use your credit score to determine your insurance premiums. A higher credit score could result in lower premiums, while a lower score might lead to higher premiums.

Employment Opportunities

Some employers, especially those in the financial industry, check applicants’ credit scores. A poor score might impact your chances of getting hired for certain jobs, especially those that involve handling money.

How to Improve Your Credit Score in 5 Steps

Now that you know how credit scores work and why they matter, let’s take a look at how you can improve your score. Here are some 655

1. Pay Bills on Time

Your payment history accounts for 35% of your credit score, making it the most significant factor. Set up automatic payments or reminders to ensure you never miss a due date. Even a single late payment can negatively impact your score.

Even if you can’t pay the full amount, make at least the minimum payment to avoid late penalties.

2. Reduce Your Credit Utilization

As mentioned earlier, credit utilization (the percentage of available credit you’re using) is a key factor in your credit score. Aim to keep your credit utilization rate below 30% of your total available credit. For example, if you have a $5,000 credit limit, try to keep your balance below $1,500.

If you have a high credit balance, consider paying it down or asking for a higher credit limit.

3. Check Your Credit Report Regularly

It’s important to regularly check your credit report for errors or inaccuracies. Sometimes, mistakes can appear on your report that could harm your credit score. If you spot any errors, dispute them with the credit bureau to have them corrected.

In Canada, you are entitled to a free copy of your credit report once a year from each of the major credit bureaus—Equifax and TransUnion.

4. Avoid Opening Too Many New Accounts

Each time you apply for a new credit card or loan, the lender performs a hard inquiry on your credit report. While one or two inquiries won’t have a major impact, multiple inquiries within a short period can lower your score. Only open new credit accounts when necessary.

5. Keep Old Accounts Open

The length of your credit history accounts for 15% of your score. The longer you’ve been using credit responsibly, the better. Closing old accounts can shorten your credit history and hurt your score, even if they’re not being used.

Keep old accounts open, but avoid overspending on them.

How Do Credit Scores Really Work in Plain English

Understanding your credit score and how it works is essential for maintaining good financial health. By knowing how your credit score is calculated, why it matters, and how to improve it, you’re in a much better position to take control of your finances. With some diligence and a few smart financial habits, you can boost your credit score, save money on interest, and access more opportunities in your financial life.