S7 E03: Credit Scores

So we're talking about credit cards like MasterCard and Visa, car loans, mortgages, cell phone accounts, and that's where credit is actually involved. So that would be like a pay-after cell phone plan. If you have, for example, a pay-as-you-go cell phone nothing wrong with that, but that's not technically credit. Because you're not using something before you pay for it, you're paying for it and then using it.

So when it comes to cell phones, we're talking about when you have like a two-year plan with a provider, for example. So that information gets reported to Equifax. And it lands on the credit report of the person who has that account. So each one of us who uses credit in Canada would have a credit file or credit report. This is often also called a credit history. So we use these terms interchangeably. I try to just say credit report for standardization, and I always fail miserably.

So I will end up probably saying credit file and history at some point. So over time, as your different credit accounts get reported to the bureaus, that is building your credit history or your credit report at both of the bureaus. So the type of information that is coming in about each of these accounts would be the current balance on the account. If it's a credit card or a line of credit, there would be the concept of the limit on the account.

So what is the credit limit on that particular account? If it's an installment loan which would be more like a car loan or a mortgage, there would be the information around the original amount of that loan and then what the current balance is. There's also some other information reported about your payment history on that account. So each account has a rating assigned to it. Which is assigned by the lender and it reflects how up-to-date or late that particular account is.

You may have come across this before. Often people use the letter R, so they're always a letter and a number together. So you might have heard like R1, R9, some of those thrown around. What that means is the letter portion talks about the type of account it is. So R stands for revolving. It could be an M for mortgage. It could be an I for installment loan. There are a few different letters. And then the number part is what conveys how up-to-date or how late an account is.

So the best number to have is a one. That's telling the creditor is reporting that you are paid as agreed and up to date on that account. The numbers increase depending on how late payment is. So 2 would be 30 days or between 30 and 60 days late. A 3 would be between 60 and 90 days late, and so on. All the way down to a 9, which indicates that the creditor has written off the account. So that could be a situation where someone declared bankruptcy, and that account was included.

It could be a situation where the person hasn't declared bankruptcy, but the creditor has written it off because they've had so much trouble collecting on the account. Anyway, that's the overview of the type of information that gets included on credit reports. It's all data that gets reported to Equifax. So we're not going out and asking. We're not contacting your bank and saying what's Doretta's current visa card balance, for example. It automatically is reported on a monthly basis.

And the timing of that is related to your statement timing. So you and I could both have, say, Mastercards from the same bank. But maybe my statement period ends on the 19th of the month every time because of when I signed up for that card, and maybe your statement ends on the 25th, and that's when your statement balance gets finalized for that statement period.

So you would expect to see your credit card data getting updated around the 26th in the next day or so after the end of your statement, whereas I would expect to see it around the 20th, a little bit earlier, corresponding with my own statement period. And what is getting reported is the balance at that time. So sometimes people are surprised when they go, say, through their online banking and they pay off their visa card, so the balance goes down to zero.

And then they look at their credit report, and they don't see a balance of 0 and wonder, well, what's wrong. I've just paid it down. And that's because this information is getting reported on a monthly basis. So it will be what the balance is the next time the cycle rolls around. So just something to be aware of. That they-- credit reports are a snapshot in time, but that snapshot isn't always today's data. Right up to date.

Other types of information that get reported to credit bureaus and land on credit reports are things like items and collections. So that would be a situation where somebody is very late on a bill. And typically, when it goes 90 days late or worse or later than that, it can go to a collections agency. And in that case, there is a new entry on the credit report that is correlated with that item in collections.

And once an item goes into collections, that will stay on somebody's credit report for six years from the time that it went into collections. So even once it gets paid off, it's not six years from the time it gets paid off, it's six years from when it initially went into collections. So that's something to be aware of.

Sometimes people are a little surprised that they see a collections item that they have taken care of, that they have paid it off, and why is that still on my credit report, so that's what's behind that scenario. Some legal judgments can end up on credit reports as well. And those are typically related to financial matters. So if you have a judgment as part of a court case. And some of the more common examples would be unpaid taxes.

So Canada Revenue Agency might have that go through the courts that you have a certain amount of unpaid taxes that would appear as a judgment on your credit report. Another common one is family support payments that haven't been made. So that information can go on the credit report as well.

And what the credit bureau does is take all of that information, and presumably, they have all kinds of-- they do some kind of magic algorithms I don't know, hocus pocus. And all of that financial information goes into a credit report.

Most banks and Lenders will require that when you're applying for that new credit account, you give your consent or your permission for them to access your credit history from one of the credit bureaus. And they use that information as one of the inputs into their decision-making process on whether or not they will open this account for you. And in some cases, also what interest rate you might get for a particular loan.

Is it is a predictive analytic that is intended to predict this behavior where the behavior is repaying bills on time.

And it's important to understand the answer, there is absolutely nothing. You're not doing anything wrong. The reality is that if that person applies for a new credit account with a bank, and let's say that somebody else applies for the same credit account and that person has a score of 880. So we've got two people with two credit scores that are hundreds points different. The bank, in most cases, is going to interpret those two people as being the same level, which is excellent.

It ticks the box. That's all the lender is concerned about on the credit score front. So it's important to note that it's rare that Lenders and banks make decisions just on the credit score. There are a lot of other factors that go into those decisions. Some of the common ones would be employment status. So is this person employed and getting a regular paycheck? What is their actual income? What wealth or holdings do they have, depending on the type of credit they're applying for?

But that's one of the uses of credit scores that some people wouldn't think of right away as being something that matters. That the next time you're applying for a new rental unit, that might come into play. Another common one-- it's becoming more common is some employers make a credit check part of the requirement for getting the job. So, for example, I had that experience when I applied at Equifax. So when I got the job offer, it was conditional on two things.

One was a police background check. And that would be familiar to a lot of people. There are lots of jobs that require that. But the second was a credit check, and that's relatively common in financial services. So you might find a lot of people working at big banks, and some of the other financial entities would have had a condition like that as well. So it can actually affect employment prospects too.

One of the common ones is a secured credit card. So not all institutions offer this, but there are a few choices out there. And the basic idea is that you give that credit card issuer a deposit. And so maybe it's a deposit of $500. And then that credit card will have typically a limit of $500 or maybe a little bit more. And so you're basically giving them some collateral so that if you don't make your payments, they have that deposit that they can draw that money from.

It can take as little as like three to six months of just getting that positive data coming in where you're making those bill payments on time, there aren't any late payments. It can be that short, three to six months before someone starts to get a credit score calculated. There's a minimum amount of data that is required on the credit file in order to be able to calculate a score. So that's why there can be-- it takes a few months at least to collect that data in order to calculate a score.

One of the things that a lot of people don't realize is that credit scores were actually developed in order to create a level playing field for all of us here in Canada applying for credit. So come on a little imagination journey with me for a minute and think about somebody, say, 100, 150 years ago, applying for credit at their local bank. So they're going to have to go in person. They're going to meet with the bank manager.

And the bank manager is going to make a decision on whether or not to give that person a loan, probably based on whether they know the person, whether they like that person's family, and other factors which really are subjective. And so that was the genesis of credit scores.

Was let's come up with a standard, a consistent way of managing-- it's almost along the lines of a financial reputation so that you can be paying off your debt really well in one province and move to another province where you don't know anyone, the bank manager isn't going to know you, but you still have the benefit of them being able to access your positive credit history and seeing that you're likely a pretty reasonable risk.

So it really depends to say how long does it take to rebuild after having a difficult credit situation. There isn't a one size fits all answer to that. Because it depends on what the nature of the situation was. So are we talking a few missed payments, are we talking one item in collections, three items in collections, a bankruptcy? There's a whole spectrum of different situations that can occur. So some of the common ones that people might have heard of bankruptcy is at one end of the spectrum.

And once someone declares bankruptcy, they will have trouble qualifying for credit for a period of time after that because there has been a demonstration that they, unfortunately, weren't able to meet the obligations that they had originally signed up for. But there's a bit of good news here. There are a lot of protections in place where negative information like that can't follow you around for the rest of your life. So we're actually regulated provincially, so it can vary a bit by province.

Some provinces say that a bankruptcy has to be off the credit report within six years of being discharged. Other provinces say within seven years of being discharged. So what we do at Equifax is we take the best one, the most stringent one, which is six years. And regardless of the province you live in, it's automatically removed from your credit report once that six-year period from the bankruptcy being discharged occurs.

So even with an item in collections where it will stay on the credit report for six years from the time it went into collections, as that item is getting older and older. So as it's approaching that six-year mark, as long as nothing new negative is being reported.

So as long as all the other accounts that are on the file are being reported as being paid on time, the impact of that one item in collections will decrease over time as it gets closer and closer to being removed from the file altogether.

What they do is a very detailed statistical analysis of millions of Canadian credit files. So they take, say, 5 to 10 million credit files from one period in time, let's say, July 21. And they're depersonalized, they're anonymized, so there's not a privacy concern there. And then they take the same people's credit files a year later, so July 2022, and they look at what has changed in that 12-month period. So you're going to have a good cross-section of people at every end of the spectrum.

People who've been using credit for a long time. People who are new to credit. People who have missed a lot of payments. People who've never missed a payment. So you've got a good collection of different credit file characteristics. And they look at for all the people who made their payments on time, what do they have in common? For all the people who declared bankruptcy, what do they have in common?

What do we see that look like there may be leading indicators of the likelihood that somebody might start missing payments? When we look at people who had a good solid credit history in the first sample, but then that person has started missing payments in that 12-month period, what can we tell from that data? And the answers to those questions become the factors that go into the credit score calculation.

So it turns out that the most predictive piece of information that is in somebody's credit report is their payment history. Somebody who has made all their payments on time is more likely to continue making payments on time. Of course, I'm oversimplifying here for the sake of clarity. But the basic idea is that there are factors identified which are correlated with certain repayment behaviors. So when we look at missing payments.

So people who have started or continued to miss payments, what can we see about them in the earlier sample that might help us make a correlation there? And one of the things that you see is late payments, to begin with. Having items in collections are correlated with missing payments. People with judgments on their credit report. So financially related court judgments. So the impact of having debt on the credit score is really related to the repayment habits.

That really is the number one factor. Then there start to be some other factors that are taken into consideration in the scores. So another one would be what we call utilization. That's the difference between the balance that was reported typically on a revolving account. So we're talking about a credit card or a line of credit here. The balance that was reported to Equifax versus the credit limit on the account.

So as an example, if you have a credit card that has a credit limit of $4,000 and the balance that got reported to Equifax the last time that account reported was $2000, then you're at a 50% utilization. You're using half of your available credit. There is a correlation between higher balances, so higher utilization, the balance relative to the limit. There's a correlation between that and missing payments.

And so typically, a lower utilization-- so being able to keep balances lower relative to the limit on those types of accounts can be helpful when it comes to credit score calculations. DORETTA THOMPSON: So, to be clear, it is perfectly possible to have debt but to have it in a way that you can still have a good credit score? Absolutely.

The reason that information has to be on the file is because all of us as consumers have the right to know who has looked at our credit data. And there are two categories of these access entries. And the term we use in the industry is inquiries. So each one of these entries in the log would be called an inquiry against the credit file. There's two categories of inquiries hard inquiries and soft inquiries. The difference is the reason the credit file was accessed.

So if the reason was that the person was a applying for credit. So that example where you walk into your bank branch, they've got a cool new visa card that you want, so you make your application, they ask for your consent to check your credit history, you give the consent. They pull your file. There's now going to be a new hard inquiry on your file that indicates that credit card issuer pulled your file on that day. The other category of inquiries is called soft inquiries.

And those are where the reason for pulling the credit file wasn't related to a credit application. So that's where the landlord is pulling the credit file, for example, or the potential employer. Or the big one is the person themselves checking their own credit report. Which is something we should all be doing. You can access credit reports for free online. It's such an important step to make sure everything looks accurate. We can come back to that.

But that will be recorded on the report as well. Just saying that you yourself checked your own credit report. That's a soft inquiry. Now the reason I'm making this distinction is that hard inquiries can have an impact on credit score calculations. They won't always, but they can. And let me explain that a little bit more. What a hard inquiry represents is an application for new credit, as I just outlined.

And there is a statistical correlation between people applying for a lot of credit in a short period of time and then starting to miss bill payments. So that's why that factors into the score calculation. So the very common question we get is, well, oh gosh, well, how many points am I going to lose every time I apply for a new credit card? It's such a simple, easy question. Unfortunately, the answer is not.

Because the reason it may affect some people and may not affect others is related to these predictions of credit behavior based on information in the credit report. And I know this is hard to follow, but please bear with me for a minute. Somebody who has missed a number of payments maybe has an item in collections on their file.

There is a stronger statistical correlation between that person applying for, say, three or four, or five new credit accounts in a 12-month period and that person is starting to miss payments. So that person applying for a new card might see their score go down as a result of this new hard inquiry.

But if you compare that to somebody who has a solid long credit history, who's never missed a payment, that person could apply for the same number of new credit accounts and have that same number of new hard inquiries on their credit report and not see a difference because of that difference in risk correlation.

But there are actually different versions. Different banks use different credit score versions. So the version that you see when you're looking at your bank website, for example, or through one of the free sites that will give credit scores, that's not necessarily the same version that a bank is using. That might not be the same one that particular lender is using. And people fixate so much on the score, on that number, but it's gone down by 2 points. Oh, it's gone up by 3 points.

Great, I'm coming out ahead. The important thing to focus on is the credit report because all the scores are based on that data that is in the credit report, and that's where you want to make sure that data is accurate. So when you're asking about how often should somebody be checking their own credit report? I would say a minimum of once a year is important. And you want to make sure that you're checking at both of the credit bureaus, so both Equifax and Transunion.

You want to look at your credit reports at both. It's rare, but there are sometimes mistakes that happen, and that's the kind of thing that you're looking for. So a few examples would be sometimes, if someone has a similar name and address or address and birth date, or similar combination of characteristics, you might end up with some of their data landing on your credit report. So that's something that you want to get cleaned up as soon as you find that sort of thing. Another possibility.

And this one is a little more scary. Is that you could find an account on your credit report that you don't recognize, and that might be because somebody has impersonated you and applied for credit in your name. And this is one of the first ways of noticing, finding out that has happened, and being able to do something about it before you're trying to finalize that mortgage or you're applying for that car loan.

That is not the time that you want to find out, wait a minute, somebody took a credit card out in my name and didn't pay it, and now this account is in collections in my name. That's a stress that you don't need when you're trying to finalize a major financial purchase.

They can help process that. They will also authenticate you using information on your credit report. You can also mail in a request if you prefer, and you can have a report sent to you in the mail, a paper copy. And there are some requirements there that you can find on the website as well about providing proof of your ID.

DORETTA THOMPSON: And I do want to say that links to all this information will be provided on the web page that goes with the podcast so you can find it-- for all our listeners, you'll be able to find that information there. So-- and you're saying we should check it at least once a year and with both of the credit bureaus because there can be a difference between them. There is always the possibility of a difference.

So lenders are not actually required to report to credit bureaus in a lot of cases. So you'll find the major banks and credit unions, those familiar names. You're going to find those accounts at both Equifax and Transunion. But some of the newer players, some of the newer alternative lenders, for example, they may report data to only one of the credit bureaus, or they might not report to either credit bureaus.

So there are some possibilities where you could actually see some difference in accounts between your credit files at the two different bureaus.

Just give us $300, and then we'll contact the Bureau and get them to remove it. We have special tricks. The reality is that the only person who we will talk to about your credit report is you unless you have given a legal power of attorney to another individual to take care of that on your behalf. So when a credit clinic says we'll contact the Bureau and get this negative information removed on your behalf, it's a bold lie. They cannot possibly do that.

If there is information on your credit report that is incorrect, so that example of an item in collections that isn't actually yours and landed on your credit report by mistake, it is free for you to contact the Bureau, provide the evidence and they will do an investigation for free get back to you with the results and remove it if it should not be on your credit report.

So none of this stuff costs money, but unfortunately, a lot of these credit repair clinics have very targeted social media presence and advertising where the people that they are targeting are the only people who are seeing their ads. So a lot of people who wouldn't be in a desperate situation might not even see these ads for credit repair clinics.

And sometimes we see these very just heartbreaking situations where somebody has done the right thing, they're getting concerned about their ability to meet their financial obligations. They go and talk to a not-for-profit credit counselor who goes through their credit file with them, goes through all of their obligations, what's your current income.

They take a look at your personal situation and explain that it's going to take a while for your score to go up because you've got these negative things on the file, but it will improve as long as you don't continue having new negative pieces of information getting reported. But that's not the message people want to hear. They want to hear some kind of overnight quick fix.

And so sometimes that person is then susceptible to this advertising, which says for only $300 every year for the next five years, we'll help you manage your credit. And sometimes, those people end up back at the credit counselor after having had that heartbreaking experience, and now they're owed that extra money that they couldn't afford in the first place and not seen any positive benefit from.

So it's so important for people to understand there are lots of resources to figure out which credit counseling agencies are not for profit and which ones are accredited, and the ones that you should be talking to. As well as licensed insolvency trustees as another option. They're federally licensed, so they're in a good position to be able to offer the right advice for your particular situation.

It's OK to have some issues that need to be dealt with. There are so many resources out there to help.

And if you'd like to get in touch, our email is financialliteracy@cpacanada.ca. This season is proudly brought to you by BDO debt solutions, helping you turn the page on debt. Please note the views expressed by our guests are theirs alone and not necessarily the views of CPA Canada. This is a recorded podcast. The information presented as current as of the date of recording. New and changing government legislation and programs may have come into effect since the recording date.

Please seek additional professional advice or information before acting on any podcast information. Be well, be kind. And remember, managing debt is within your power when you're informed, prepared, and vigilant.