How to build credit in Canada?

Building strong credit is crucial if you’re striving for healthy personal finances. It allows you to access better credit cards and loan terms, enjoy more favourable interest rates, and can even make it easier to get an apartment or find a job.

In Canada, there are several effective strategies that you can use to build creditworthiness and make yourself more attractive to lenders, and pave your way for future financial success. This article will delve into crucial aspects of credit in Canada, such as credit scores and credit reports, as well as steps you can take to strengthen your creditworthiness. By doing so, you’ll have the knowledge you’ll need to make informed financial choices and lay a solid foundation for long-term prosperity.

What are credit scores?

Credit scores are three-digit numbers that represent an individual's creditworthiness. Creditworthiness is a measure of how likely you are to repay your debts and manage credit responsibly. In Canada, credit scores range from 300 to 900, with 300 being the lowest possible score and 900 the highest. Generally, the value of your score is as follows:

• Excellent: 760 and above

• Very good: 725 to 759

• Good: 660 to 724

• Fair: 560 to 659

• Poor: 300 to 559

Credit scores play a crucial role in financial transactions and are used by lenders, landlords, and other institutions to assess a person’s creditworthiness before they are given loans, mortgages, rental agreements or other forms of credit. If a lender decides that you aren’t creditworthy, then you have a much lower chance of getting approved for credit.

The importance of having strong credit can’t be overstated. A good credit score is essential in order to get favorable terms, like lower interest rates, more flexible loan terms and higher credit limits. It also influences how easy it will be to successfully apply for an apartment and may even affect your employability. Additionally, it’s important to note maintaining a positive credit score is an ongoing process because scores and credit reports are constantly being updated by Canada’s two credit bureaus (Equifax and TransUnion) and can fluctuate often depending on your spending and borrowing behaviours.

Luckily, building up a strong score can be a relatively straightforward (if long) process because credit bureaus are generally transparent about what factors go into calculating your score. The key factors that determine your score are:

1. Payment history: Worth 35% of your overall score, payment history measures how good you are with making payments on time and it’s the most crucial component affecting your overall score. Late or missed payments will decrease your score significantly over time.

2. Credit utilization: Credit utilization, which makes up 30% of your score, is the amount of credit you’re using versus have much credit you have available. Aim to keep your ratio under 30%.

3. Length of credit history: Accounting for 15% of your overall score, you’ll have a higher score the longer your credit history is because it gives credit bureaus information about how you manage credit over time.

4. Inquiries: Worth 10% of your score, inquiries happen whenever a potential creditor looks into your score and credit report. If you apply for too much credit in a short period of time, it could harm your score.

5. Public records: Public records, approximately 10% of your score, can have a detrimental effect if they reflect negative information, such as bankruptcy or credit accounts sent to collections. Such records lead to a decrease in your score as they indicate that you might be a credit risk.

Note that TransUnion considers credit mix (the different types of credit you have like mortgages, credit cards and loans) as a factor when calculating your credit score so the exact components of your score may differ slightly between Canada’s two credit bureaus. Nevertheless, the main factors to really focus on (since they are given the most weight) are payment history, credit utilization and credit history.

How can I establish a credit history?

The first step to building credit is to establish a credit history, which means you’ll need to actively use credit and demonstrate responsible borrowing and payment behavior over time. Of course, you can’t develop a credit history until you actually open your first credit account so it’s important to get started as soon as is reasonably possible.

Establishing a credit history can be especially challenging for those who have to build credit from scratch, like those just heading off to pursue a post-secondary education or newcomers to Canada. That’s because creditors such as credit card providers and loan managers have nothing to go on when it comes time to assess your creditworthiness. That being said, while it can be a bit of a struggle to get your first credit account, it’s certainly not impossible (after all, even those people with excellent credit scores all started from zero).

Establishing a favourable credit history can also be challenging for those who have a low credit score due to mismanaging their credit accounts through late payments or bankruptcy. The good news is that whether you’re just starting out on your credit-building journey or have a history of bad credit, there are several things you can do to start building credit:

1. Secured credit cards: Secured credit cards are arguably the best tool for credit newbies to establish credit. Unlike traditional (aka non-secured credit cards) secured cards are generally easy to successfully apply for because there is almost no risk to the issuer. That’s because you provide a security deposit that serves as collateral in the event you default on your payments. Whatever amount of deposit you provide becomes your credit limit. By using the card responsibly and making timely payments, you can build a positive credit history. Over time, your credit card provider may even offer to upgrade you to an unsecured card.

2. Credit-builder loans: Rather than taking out a loan to receive funds, credit-builder loans are designed specifically for building credit. Unlike traditional loans, the loan amount is not given to you upfront. Rather, the money is usually held in a savings account by the lender. Your regular payments toward the loan are reported to credit bureaus by the lender and thus contribute to your credit history.
   
   Unlike in the United States where credit-building loans are relatively common, this type of credit can be hard to find in Canada. One option worth considering is KOHO’s Credit Building program. It allows you to improve your credit score without putting up a deposit. KOHO provides an unsecured credit line and makes monthly payments on your behalf. Those payments are then reported to Equifax. This is a great hands-off approach to credit building.

3. A relatively new credit-building option in Canada is to use your rent payments to build credit. With programs like FrontLobby, you may be able to get your landlord to report your on-time, in full payments to a credit bureau and thereby increase your credit score.

Remember, building credit takes time and diligence. With all the options mentioned above it will take time to see results and it’s essential to manage your credit responsibly.

How can I use credit responsibly?

Using credit responsibly is a fundamental component of building a healthy credit. Here are some things you can do to use credit responsibly:

• Create a budget: It may sound boring but creating a budget is one of the single most important things you can do to encourage responsible credit use. Create a budget that outlines your income, expenses, and financial goals. Be sure to allot the majority of your money to essentials like rent, food and savings, but it’s ok to put aside some space in your budget for fun things too. Just be sure to put the focus on your needs and not your wants. As your income and savings grow, your budget can evolve to make more room for wants like vacations and eating out. A budget will help you understand how much you can afford to spend and ensure that you don't overspend or accumulate unnecessary debt.

• Limit credit card use: While having a credit card can be helpful for building credit, it can be incredibly harmful if you don’t use it wisely. Don’t max out your credit cards — which can lead to quick-to-accumulate, hard-to-pay-off, high-interest debt— and try to keep your credit utilization ratio (the amount of credit you use versus your overall available credit) below 30%. High credit utilization can negatively impact your credit score.

• Pay your bills on time: Prioritize paying your credit card bills and other debts on time. Late payments may not only result in late fees, they can also lead to increased interest rates, and also have a large negative impact on your credit score. A smart idea is to set up automatic payments via your bank or set monthly calendar reminders so that you never miss a payment.

• Pay more than the minimum payment: Try as hard as possible to avoid just paying your credit card’s minimum payment. Though it can be tempting to just pay the minimum, credit cards have some of the highest interest rates of any credit product in Canada and can lead to overwhelming debt. By paying the full amount or, at the very least, as much as you possibly can each month, you'll reduce your overall debt faster and minimize the interest charges.

• Avoid unnecessary debt: Before making a purchase, ask yourself if it's a want or a need. Don’t put anything on your card that you can’t pay off by the time your bill is due. Otherwise, that $300 TV can quickly balloon to a real-world cost of $1000 once you start paying interest on it over months or years.

• Regularly review your statements: Mistakes happen so make it a habit to review your credit card statements and ensure that all charges are accurate. If you spot any unauthorized charges, contact your credit card provider immediately.

How can I build a positive credit history?

Obviously, it’s not enough to simply establish a credit history by getting a secured credit card or using a credit-building tool. You’ll also want to ensure that the credit history you build is positive. Here’s some tips:

1. Monitor your credit reports: Regularly check your credit reports from Canada’s two major credit bureaus (Equifax and TransUnion) to ensure the information is accurate and to track your credit score.

2. Gradually apply for more credit cards: After several months of responsible credit card use with a secured card, you can consider applying for an unsecured credit card. You won’t need a security deposit so unsecured cards are more difficult to get, but as your credit score rises it will become easier to successfully apply for credit.

3. Credit building: Look into a credit building tool like KOHO’s Credit Building option. KOHO provides you with a loan and makes payments on your behalf, which are then reported as payments to Equifax.

4. Pay your bills on time: Payment history is the biggest factor of any credit score, and even one late payment can cause your score to decrease.

5. Maintaining a low credit utilization ratio: Credit utilization is the second biggest component credit bureaus take into account when calculating your score. Keep it below 30% by ensuring you are never carrying too much debt on your cards or lines of credit.

6. Diversifying credit types: It’s good to have a mix of different types of credit accounts, such as loans, lines of credit, credit cards, and mortgages because credit bureaus’ credit scoring models often consider credit mix when calculating your score. Credit bureaus and potential lenders like to see that you know how to handle different credit accounts.

How to monitor your credit report?

Monitoring your credit report is a good habit to nurture as it ensures you’ll always be aware of your credit score and your overall financial health. It can be overwhelming the first time you look at your report but take the time to familiarize yourself with the components of a credit report, including personal information, credit accounts, payment history, and public records. Understand how information like payment history and credit mix impact your creditworthiness.

Many people also may not realize that they can get a free copy of their report by contacting Equifax and TransUnion. When you get yours, start by reviewing it for accuracy. Carefully scan for any discrepancies, incorrect personal information, or unfamiliar accounts that could indicate errors or — worse yet — potential fraud or identity theft. If you do see accounts you don’t recognize, contact the credit bureau.

If there is a specific issue with one of your credit accounts (such as a payment you made on time being reported as late) you can initiate a formal dispute with the credit bureau. Both Equifax and TransUnion each have their own dispute process. Initiating a dispute is free and credit bureaus are required to look into any potential errors. Provide supporting documents and follow the steps outlined on the credit bureau’s website. They will then investigate and inform you of the outcome, usually within a month.

What are some long-term credit building strategies?

The best long-term credit building strategies involve maintaining responsible credit habits not just for a few months but over years. For that reason, patience and consistency are key components of any successful credit-building plan. Building a positive credit history takes time and requires that you strive for good credit practices, including paying your bills on time, keeping your credit utilization low, and sticking to a carefully conceived budget.

As your credit history improves, you can move on to more credit products, such as graduating from secured credit cards to unsecured cards. Unsecured credit cards offer higher credit limits (which could help give you a better credit utilization ratio), don’t require a security deposit and may even feature useful perks like travel rewards, big welcome offers and free insurance.

Remember, credit building doesn’t happen over night. You’ve got to be patient, focused, and responsible with managing credit. Over time, your credit score will improve, and you will have access to more favorable credit products, interest rates and terms, which in turn makes it even easier to stay on the path to positive credit building practices.