Here’s how your credit score is calculated (and how you can improve it)

Almost everyone has a credit score, and whether you know yours or not, it has a big impact on your life. Despite that, credit scores remain a mystery for a lot of people — what impacts them? How are they calculated? How can a score be improved?

We talked to Julie Kuzmic, senior product manager of Consumer Credit Scores at Equifax Canada, to get an expert take on everything you need to know about credit scores.

What exactly is a credit score?

Let’s get the basics out of the way. A credit score is a number used by financial institutions and lenders to quickly predict how likely someone is to repay their debt. The number ranges from 300 to 900 and the higher your score is, the better. Most people get this part.

Now here’s where things get tricky: you don’t have a credit score. You have several.

Credit scores are calculated using several different algorithms

Credit scores are calculated using complex algorithms and statistics by credit reporting bureaus. In Canada, there are two bureaus:  TransUnion Canada and Equifax Canada. Kuzmic says that credit score algorithms are created by analyzing the credit files of millions of Canadians at a given point in time and comparing them to the same files several years later. By looking at the data in the files, they can see what indicators most accurately predict the behaviour of different segments of the population. After all, a freshly graduated high school student in a rural town and a young professional in Toronto are bound to have very different credit files, but they might still need to apply for a mortgage. That high school grad's credit score is going to be calculated differently than the professional's.

"The simplest explanation is that various components of the credit file may be weighted differently for certain custom uses of scores. However, ‘generic’ scores are most commonly used.", says Kuzmic. This is why your TransUnion score and your Equifax score will be different. They use different algorithms and scales to do the same thing, but they’re different enough that you won’t get the same results. This is maybe the most important thing to remember about credit scores — there are lots of algorithms out there, not just one.

What affects your credit score?

A lot of people want to know what they can do to improve their credit score, and to do that, they need to know exactly what these credit bureaus are looking at when determining their score. Well, it’s actually just a handful of things that they look at in your credit file, according to Kuzmic.

Payment history. By and large, the most important indicator in your credit file is what your history of servicing your debt is. How much debt you have doesn’t matter so much as you have or how long it takes you to pay it off, as long as you have a long history of making your payments on time, most lenders see that as a good sign when making credit decisions.

Percentage utilization. How much of your available credit are you currently using? As a general rule, having a higher percentage makes it less likely for a consumer to be able to service new debt. Basically, if you had $5,000 in debt and a limit of $10,000, that 50% utilization doesn’t look as bad as someone who has $5,000 in debt with a $6,000 limit. So if you’re paying off multiple credit cards and start cancelling them as soon as you pay them off, you may actually be hurting your score.

Credit history. This refers to the length of time you've had a credit file. The longer your history of using credit is, the more accurate your score can be. There’s a minimum amount of credit activity someone has to have on their file before a score can be created. Things that determine credit history can range from applying for credit cards, loans, paying your cell phone bill, utilities, rent, and merchandise payment plans from stores.

Delinquency history. This is an important one. If you have a history of missed or late payments, your credit score is going to take some damage. Any unpaid debts that have gone to collections are the most damaging, because it will be years before they’re taken off.

Inquiries. How many credit products are you applying for? These are called hard inquiries and they’re the reason why you’ve heard that applying for credit cards or loans can hurt your score. This is technically true, but it doesn’t affect everyone, because like any other factor, the score algorithm weighs this data differently for different people. For some people, having a high number of inquiries won’t affect their score much at all. Also note that even though you will see how many times you’ve checked your score on your own report, those inquiries are left off the file for everyone else. That means soft inquiries don’t affect your score in any way.

What credit bureaus DON’T look at when determining your score

Credit scores are simply used to predict your behaviour and whether you will pay your debt, not whether or not you can. Credit files don't include any info regarding your income, savings, or other assets.

You should check yours every year to ensure it’s accurate

Even though credit scores are proprietary, credit files are not. What’s more, you can get a free copy of your credit file at any time just by asking for one. It’s recommended that everyone check their credit reports from both TransUnion and Equifax every year to ensure the information is accurate. In many ways, this information is more useful than simply knowing one of your credit scores, but if you do want to get a good idea of where you stand, you can order a report, including your score, from either credit bureau for a fee or get a free score through a financial service like Borrowell.

The scores you’ll get are 100% legitimate credit scores. But because the score version you’re getting will likely be the “generic” score, it may not reflect the same score a financial institution would use to process your application for say, a business loan.

The one surefire way to improve your credit score

Don't try to game the score. Just pay your loans on time and your score will be fine. This is why it’s important to always make sure you cover your minimum payments, no matter what.

Hopefully now you have a clear idea of what a credit score is and what affects it. Some people think there are “secret tricks” or other methods to ensure a good score. The reality is much simpler. Pay your debt and make sure your file is accurate, and your credit score will get better over time.