In order to get credit, you need credit — it’s one of life’s greatest frustrations.
That’s all fine and dandy, but do you know how to build credit? Like, really know and understand how?
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Money and credit management must work hand-in-hand to have access to credit when you need it. People who pride themselves on never having dipped into credit have done themselves no favours, and they’ll find that out the hard way when buying their first vehicle or home.
So how do you get credit when you need credit to get credit? (Have a headache yet?)
Why you should build your credit
It’s very important to establish credit, and to do it early and effectively. Good credit is vital if you want to qualify for a mortgage, buy a car or even a cell phone. So much of what you need in life requires good credit. But, what’s the best way to build credit?
How long does it take to build credit, or improve credit in Canada?
The bad news is that you can’t build your credit overnight, but it won’t take as long as you might think. It’s highly dependent on your commitment to improving your credit score.
If you’re starting from zero, it can take between three and six months to build up enough evidence of good credit management to affect your credit score. It depends on what methods you’re using to build your score and how effective you are at managing it.
There’s no hard-and-fast rule for how long it takes to improve a poor credit score — it depends on which methods you use to improve it and how bad your credit was to begin with. On average, though, you can expect at least three months of good financial management to see a change in your score.
How credit scores work in Canada
Now you know you need a good credit score, but what does that even mean?
What’s considered when calculating credit
There are six criteria used to determine your credit score in Canada:
- Payment history
- Used vs. available credit
- Credit history
- Diversity (having successfully used various types of credit)
- Public records (previous bankruptcies, for example)
- Inquiries (how often you’ve sought to get access to credit and how successful those applications were)
Your history in any and all of these areas will be combined to calculate your credit score.
What is a good credit score in Canada?
The highest score you can possibly have is 900. Anything over 780 is considered excellent. If you’re under 620, your credit is considered poor.
On average, any credit score of 680 or above is considered a good and healthy credit score, and you should be able to qualify for most applications for credit.
Most Canadians’ credit scores fall between 620 and 679.
Types of credit
A credit card is the first type of credit that typically comes to mind. Many people use credit cards to build credit. But, there are far more ways you can get access to credit funds beyond the plastic in your wallet.
These types of loans are secured against the vehicle you purchase and payment is usually in the form of regular payments. In order to get a car loan, the car you purchase needs to be less than five years old.
Personal line of credit
Think of a line of credit as funds sitting in a bank account that you have access to when you need it. Typically, lines of credit have lower interest rates than a credit card. There will be a required repayment amount, based on the amount of funds you have withdrawn, but you can always repay more without penalty.
From a bank or financial institution, personal loans are best used for longer-term needs, such as home renovations.
Chances are, many of us are already familiar with this type of protection but never really considered it credit. Overdraft allows you to go into arrears in your personal bank account, and to pay interest on the amount that’s been used beyond the cash you had available. The account must be brought above zero, with all of the overage paid back, monthly.
Sometimes, these loans are guaranteed by the government but often they are simply bank-issued loans, with low interest rates, used to help complete an educational program. Students are given both the lower interest rate, and a special repayment plan.
Mortgages are funds issued by a financial institution to purchase a home. The property you purchase is used as collateral to secure the loan. Interest rates fluctuate with the market and with the payment options and term of your loan.
Deferred payment plan
We know these as “buy now, pay later” options offered at many big box retailers. Typically, you pay a fee up front for the option to pay off the item you’re buying at a later time, with no interest penalty.
In a nutshell, you can go into a storefront and they’ll front you money for a very hefty interest fee. These are short-term loans that need to be paid back when you receive your next paycheque.
Renting to own allows you to make use of the item you’re renting, with the option to buy it when the rental term is over. You can do that by continuing to rent it until it’s paid off, or by paying it off in a lump sum. Until it’s paid off in full, the item remains in the ownership of the lessor.
How to build credit in Canada using credit cards
The fact is, to get access to any or all of the above credit options, you need an established, good credit score to qualify. Yes, a mortgage will use your house as collateral, but they’re not giving you a loan if you don’t have solid credit. So, if you haven’t started building credit yet, today is the day!
Get a credit card
How do you get credit without credit? You get a credit card. You won’t be getting a $10,000 credit allowance with your first card. You’ll likely get about $500 to play with and pay off for a while before you can apply for more. If you’re a student, you’ll be lucky enough to have card companies on campus vying to be your first credit company. If you don’t frequent college campuses, your best bet is to do some research to find which credit card companies are friendly to first-time credit card users.
Don’t waste your time applying to companies that don’t expressly say they are happy to work with new card holders. They might be willing to extend you credit, but you should apply for a card that targets your current status.
Get a secured credit card
If you are willing to go to the secured credit card route, you will have an easier time qualifying for a card. A secured credit card is like a secured loan. You provide collateral of some sort to ensure that you have the funds to pay back what’s owed. The benefit of a secured credit card is that you know you have the collateral to back up what you’re spending, and you’re able to use the card to establish credit.
Get a co-signed card
This is a great option if you have someone who will sign on to your card saying they will help if you default on your payments. These types of cards are actually hard to come by and few institutions allow for co-signed cards, but it’s worth taking the time to research finding one.
Be an authorized user on a card
This type of card is different than a co-sign. Instead of someone else agreeing to back your debt if necessary, the card you use is actually on their account, and you’re authorized to make transactions on it. They maintain primary cardholder status on the account but you are able to build credit.
Other ways to build credit (without a credit card)
Credit builder loan
Credit builder loans allow you to borrow and save at the same time. With these types of loans, money is set aside and can’t be touched until the loan is paid. By doing this, you have the money in savings as collateral for your loan. If you pay your loan off as intended, you’ll end up with the initial invested funds set aside waiting for you.
You don’t need to borrow a lot of money in order to take advantage of these types of loans. Typically, you’d put aside a manageable amount of money that you will pay back with relative ease. The whole point is to create good financial hygiene.
These loans also typically come with high interest rates, so pay them back swiftly.
Since the purpose of this loan is to build credit, the institution will send reports to both Equifax and TransUnion to help you do that.
Equifax and TransUnion are credit reporting agencies that create a credit score for you based on your use of credit. The more you use credit, the more your credit score will be positively or negatively affected. These scores are calculated using the information that is in your credit report. Typically, the largest considerations are your payment history, your debt load and the length of your credit history.
Secured loans are backed by an asset that the bank uses as collateral. Houses are often used as collateral, but secured loans enable you to use other valuable assets to back the loan instead. As long as it is has a significant value, a bank will grant you credit knowing they have something of value to ensure you pay it back.
Like getting a co-signed credit card, you need a friend or family member who’s willing to take full ownership of the loan should you fail to pay it back. The legal requirement for repayment falls on their shoulders, based on their credit.
Lots of cell phone companies require good credit to get a phone in the first place, but there are companies out there that are happy to take on customers with bad or no credit. Pre-paid carriers are a great option for people with less-than-stellar credit.
Some companies will require a security deposit. Some might demand a co-sign. Definitely shop around to see which solution makes the most sense for you if this is a route you want to take to build your credit.
Good personal finance habits to build credit
There is a lot you can do to have good financial habits, or reform yourself if you’ve gotten into bad ones. This list is far from exhaustive, but here are some good tips you can use to create good habits and build credit.
Don’t buy what you can’t afford
You’d think this should go without saying but, given that the average Canadian carries a $4,154 balance on their personal credit card, lots of us buy what we can’t afford. It’s a bad habit to get into and the best way to avoid it is to try to break the habit.
Set reasonable and realistic goals and work towards them
A part of living within your means, is achieving your goals, while still being able to eat, clothe and house yourself. A financial or money coach can help create a plan to live comfortably now, while saving for the future.
Whether it’s price matching, comparing, or negotiating, it’s a good practice to not assume the price presented to you is the price you need to pay. Take advantage of opportunities to get what you want at the best price you can. Don’t settle for cheaper if you can get a deal on better.
Pay your bills the second you get them
The best way to manage your cash flow is to know that everyone is paid, and the leftover funds are yours. We often hear that we should pay ourselves first. But, in order to keep our creditors happy, it’s really best to make sure they are paid.
Ideally, they’re paid before they even charge you. Setting up pre-authorized payments with your creditors, especially those where charges/payments are somewhat consistent, is the easiest way to manage input and output. Just make sure there are funds in the account because that could negatively affect your credit.
Leave the credit cards at home
Just because it’s important to have credit doesn’t mean it’s important to use it. In fact, it really should just be used for the odd rainy day, or convenience purchase. If you don’t have the cash to pay for it, you should consider whether you need it.
Set up plans for savings and retirement
Don’t forget about rainy-day needs and financial stability in retirement. Ignoring the reality that there will be times you will need income that you don’t have is a sure-fire way to end up having to rely on credit you may not be easily able to get access to. Start saving for today and for the future the second you have an income. Any amount is better than nothing.
Who are the Joneses anyway? Don’t bother trying to keep up with them.
Your friends might have bigger houses, more cars or fancy things. But as long as you have a roof over your head, clothes on your body and food on your plate, you’re doing a lot better than many.
If it’s still safe and it still runs, be happy with a used car. If your house feels too small, stay until you can accumulate more equity. Maybe it means you take a day trip versus an all-inclusive vacation.
The bottom line is don’t compare yourself. For all you know, they’re in more debt than you can imagine.