There is a common misconception that people with high credit scores have the lowest amount of debt. For years we’ve been told that the almighty credit score is king. That it plays an extremely important role in your finances. Some of us even have the mentality that a good credit rating is what gives us individual self-worth. But, what if we told you that what you’ve heard is untrue?
Canadians have unfortunately confused having debt with having a good credit score. We’ve worked with thousands of clients here at 4 Pillars who have fantastic credit scores but are completely overwhelmed by debt. How is that possible? In this article, we will look at how credit scores are calculated, how your debt affects your score, and why your credit score is overrated.
How are credit scores calculated?
Before we talk about what debt does to our credit score, it’s important to review what 5 major factors influence and make up a credit score.
- Payment history:
- The type of debt your carry affects your credit score. Along with that, payment history, your total balance, and the number of debts you have will also affect your credit score.
- The payment history of your debts makes up 35% of your credit score in Canada.
- Banks and lenders want to see that regular payments of those debts are being made with decreasing amounts.
- Credit Utilization:
- Also known as your outstanding debt, this is the ratio between your credit card balance and your credit limit.
- Credit Utilization makes up about 30% of your credit score in Canada.
- When applying for a loan, lenders typically want to see a ratio under 30%. Anything over 50% will dramatically impact your credit score.
- When working with clients, this is typically the biggest factor influencing their debt (more on this below)
- Credit History:
- The length of time you’ve had a credit card/how many cards you have are all considered by the bank when being considered for a loan.
- Credit history makes up about 15% of your credit score in Canada.
- The longer you’ve had credit, the more you’ll see your credit score increase.
- New credit
- This is the number of newly opened credit accounts you have and the number of accounts you’ve applied for.
- New credit makes up about 10% of your credit score in Canada
- Having either opened or recently applied for multiple credit accounts can hurt your credit score.
- Maturity/Credit Mix
- These are the different types of credit you have (line of credit, credit cards, auto loan, etc.)
- Credit mix makes up about 10% of your credit score
- This shows lenders how you can handle different types of credit.
What will happen to your credit score when you start consolidating your debt?
When you create a proposal and begin consolidating your debt, your credit score will take a temporary hit. However, this isn’t (or at least shouldn’t be) a big deal. Why? Because your credit score for one can easily be rebuilt. With the guidance of a professional who understands what they’re doing (such as one of our debt relief specialists), you can rebuild your credit score in no time.
The second reason is that your credit score is truly overrated. We’ve had many clients come to us and ask how they can consolidate their debt without their credit scores decreasing. But here’s the thing; your credit score isn’t as big of a deal as our society has made it out to be. You can have a good credit score and not be able to borrow any more money because your overall credit rating is not great.
As we mentioned earlier, credit utilization is one of the biggest factors influencing a client’s credit rating. The reason why is because they fall for the idea that to have a great credit score, they need to make all their payments on time. They make minimum payments on all their different credit cards, take out new loans. Eventually they can carry so much debt, they will never actually have the ability to pay it off. You can have a great credit score, and have a great income, but if your credit utilization ratio is too high, your credit rating will take a hit. You’ll be labeled to lenders as someone who uses credit to survive.
Many Canadians spend their entire lives catering to their debt. However, money lost to debt is gone forever. A temporary hit on your credit score can very easily be rebuilt. Which one sounds like the better option to you?
Work with us at 4 Pillars today! Everyone’s situation with debt is different, so your credit score may or may not need to take a hit to improve your debt situation. If you’re ready to take the leap and start consolidating your debt, work with us at 4 Pillars! We’ve helped thousands of people lower their debt and take back control of their finances. We’re not here for temporary solutions, we’re here to help you successfully pay off your debt & keep those debts paid off for good. Give us a call today at one of our three locations to book your free consultation. You can reach our Muskoka & Parry Sound office at 705-640-0187, our North Bay office at 705-980-0158, or our Sudbury office at 705-806-1252. Let’s get you on the road to financial freedom today!