When coming to any new country, newcomers are met with a whole new set of rules, products and ways of doing things. In Canada, most newcomers will be taken by surprise when asked about credit and credit scores and the important role they play in Canadian life – even for something as basic as renting accommodation. One newcomer recounted her story of being asked for a year’s rent in advance because she didn’t have a credit score. Like most newcomers, her response was, “What’s a credit score?”
Before we talk about scores. Let’s look at credit in Canada.
What are the different types of credit in Canada?
In broad terms, credit is the privilege of borrowing money from a financial institution (or lender) based on the understanding that you (the borrower or debtor) will repay the money at an agreed upon date and rate of interest. You may also utilize credit to make a purchase now with the agreement that you will pay later. Most major retailers in Canada offer their own credit programs, so you can buy a computer, a couch or coffee maker right now, and pay for it over time.
Types of credit in Canada
|Credit Card (Revolving Credit) — The bank allows you to access money up to a predetermined credit limit. Each time you purchase something on credit you get closer to your limit. When you pay off your balance owing (or part thereof), that amount is added back to your available credit. Interest rates vary from card to card.|
|Charge Card — A charge card comes with no interest but you are required to pay your monthly balance owing in full upon receipt of your billing statement.|
|Line of Credit (secured or unsecured) — A line of credit (LOC) is a preset amount of money that you can draw from when you need it – up to the maximum amount. You pay interest only on the amount you use.|
|Installment Loan — Repaid over a specific period of time, this loan requires a set number of scheduled payments.|
|Residential Mortgage — A mortgage is a home loan that can include payment terms of up to 25 years. A mortgage is typically renewed every few years, at which time the terms usually change.|
What is a credit score?
A credit score is essentially a numeric rating that banks (lenders) use to qualify you for a loan. Credit scores range from 300 (just getting started), 650 (the magic middle number) which will likely qualify you for a standard loan, all the way up to 900 points (the highest score).
The higher your score, the lower the risk is to the bank. A score under 650 will likely make it more difficult to acquire first time credit. The lower your score on the scale, the higher a risk you are: You will pay higher interest rates while having lower credit limit.
According to the RBC article Helping Canadians Keep Score, credit scores are calculated using a mathematical formula based on a number of factors including the type and how much available credit you have, the amount you owe, how many products you have and your payment behaviour.
The government of Canada website is a helpful resource for accurate information regarding all things Canadian, including credit scores. In their credit score basics section, they outline some of the factors that affect your credit score:
- how long you’ve had credit
- if you carry a balance on your credit cards
- if you regularly miss payments
- the amount of your outstanding debts
- being close to your credit limit
- the number of times you try to get more credit
- the types of credit you’re using
- if your debts have been sent to a collection agency
- any record of insolvency or bankruptcy
There are two main credit bureaus in Canada, Equifax and TransUnion. These private companies only collect information about how you use credit. They use this information to calculate your credit score, which they store and may share with:
- banks, credit unions and other financial institutions
- credit card companies
- car leasing companies
- mobile phone companies
- insurance companies
Note: Some financial institutions may be willing to recognize a credit history outside Canada. This may involve extra steps. For example, you may request a copy of your credit report in the other country and meet with your local branch officer.
Why a good credit score is so important
Financial institutions look at your credit report and credit score to decide if they will lend you money. They also where you are on the credit score range to determine how much interest they will charge you to borrow money. If you have no credit history or a poor credit history, it may be harder for you to get a credit card, loan or mortgage.
It could even affect your ability to rent a house or apartment or get hired for a job. If you have good credit history, you may be able to get a lower interest rate on loans. This can save you a lot of money over time. In Canada, credit scores play a greater role in daily life than you might expect.
How credit scores can affect your everyday life in Canada
New Job: A potential employers may check your credit file. Your credit behaviour or score may influence their decision on whether to hire you or not.
Renting a Vehicle: A vehicle rental company can check your credit history to assess the risk may be to them when they loan you that car or van.
Renting an apartment: The landlord may factor in your credit rating and score when assessing tenants’ worthiness and their risk.
Insurance companies, Utility companies and others also assess your credit behaviour and credit scores. That’s why it’s important to set up your bank account and get the ball rolling toward building your credit score.
How to start building a good credit history
Note: this will take time, so start now, be patient and think in the long term.
|Open a bank account now
This will be necessary for most of the following tips – and you can do it before you arrive in Canada.
|Apply for a credit card from a major bank
Using and paying regularly will demonstrate reliability and good payment practice.
|Apply for a small loan – Using your savings account as collateral
Paying back the loan on time according to your credit agreement will show you are low risk.
|Pay your bills on time
This also demonstrates your reliability and good payment practice
|Establish a steady work record
It’s what every newcomer aims to do. It also shows you have a steady income to cover payments.
Understanding credit in Canada: A closer look
To recap, credit is the privilege of borrowing money from a financial institution (or lender) based on the understanding that you (the borrower or debtor) will repay the money at an agreed upon date and rate of interest. You may also utilize credit to make a purchase now with the agreement that you will pay later. This can come in the form of credit cards, retail credit and personal loans.
The most significant kind of personal credit is a mortgage. Very few people can afford to buy a property outright, and so they must borrow a significant portion of the dollar value from their bank. In Canada, new home buyers are required to have a down payment of 20%, so the mortgage loan must cover the rest of the price of the home. Buying a home is a daunting task in and of itself – getting approved for a mortgage can be very stressful.
Banks take a number of factors into consideration before deciding on a borrower’s credit worthiness and approving a loan. Although demonstrating you have the ability to repay the loan is crucial, your credit is measured using the five C’s of credit.
The 5 Cs of Credit in Canada: Character, Capital, Capacity, Collateral and Credit
|Character describes (in the eyes of the lender) the kind of person you are when it comes to finances. Factors ranging from your credit history, length of employment, your propensity to save and whether you utilize credit responsibly all inform your character and trustworthiness to repay loans.
Here are a few questions a lender may ask to determine if you are a reliable borrower:
|Capital refers to those things you own (assets), such as a home, an automobile, or savings and investments. The lender is interested in these as ways to secure the loan (repay the debt you owe) in the event that you fail to make your payments.|
|Capacity is your ability to repay loans. Arguably the most important of the C’s, your capacity to pay back is calculated based on your job and annual income as well as payment history.
You may be asked these questions by a lender:
|Collateral adds up to additional security for the bank. The value of the house or condominium you are borrowing money to purchase, based on its value, location and characteristics is considered collateral. Collateral can also include outside parties who are willing to guarantee the loan.|
|Credit in this context, refers to your repayment history. This is the one clear way a lender can predict the likelihood of you reliably making future payments. The primary measurement used is the credit score – also known as credit history, credit report, credit rating.|
Even if you’re not ready to buy a house, it’s important to understand the Canadian financial landscape and how to prepare, budget and plan, especially when it comes to credit. Paying your bills on time, paying off debt quickly, understanding the total cost of the things you purchase, and only dealing with established, reputable financial companies will help you build a good credit history and help establish a strong financial footing in Canada.
At Arrive, we are dedicated to helping newcomers achieve career, life and financial success in Canada. As part of our focus on the financial side of your journey, we are sharing financial tips and information in our weekly blogs, providing handy online tools and hosting highly-informative webinars and workshops.
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Sources: Financial Consumer Agency – Credit Reports, Credit Canada, RBC, Financial Consumer Agency – Mortgages, RBC Credit Cards, Credit Cards Canada