64 – What Is a Credit Rating and How Does It Work?

Wayne Kay 00:04
Welcome to the Debt Matters podcast, where we help Canadians find solutions to their debt with Licensed Insolvency Trustees from across Canada. 

I’m Wayne Kay. In today’s show, we’re going to talk about credit ratings and how they work. How important is the credit report? What’s the difference between a credit report and a credit score?

How do you find these things out? And what do you do to improve your credit score and what are the numbers that maybe you should be going for? 

My guest today is Jillian Taylor-Mancusi from LCTaylor Licensed Insolvency Trustee with offices in Winnipeg and Kenora. Hi, Jillian. Welcome back.

Jillian Taylor-Mancusi 00:47
Hi, Wayne.

Wayne Kay 00:48
It’s always a pleasure. And we get into these great discussions, and today I’m looking forward to this deep dive into credit ratings.

So, first off, let’s talk about a credit report. What is that?

Jillian Taylor-Mancusi 01:00
So if we back up a little talk about why we need a credit report and what a credit report is, we have to look at why a financial institution would even look at a credit report. And that would be because financial institutions are in the business of risk management. So basically, they make money by loaning money and charging interest rates on the loan.

Now, the trick for the financial institution is to balance between the need to loan money and the risk that some of that money may never be paid back. For example, there are some clients that would never default on a loan, while on the other hand, there are some that will. 

There are really two kinds of lenders. Conservative lenders, which is like your bank or your credit union. They really keep the risk at a minimum and have really strict borrowing criteria versus a high risk lender at the other end of the spectrum, and they’re prepared to take a little bit more risk. 

Maybe you have a lower income or you don’t have any security or collateral that you can offer to the loan, or you don’t have steady employment. And really, the difference between the two is the interest rate that you’re going to get. So with a conservative lender, you might end up with like a 10% or 11% interest rate, whereas with a high risk lender, you might end up at 35 or 36%.

Wayne Kay 02:22
His name is Vinny and he works in an alley, by the sounds of things… 35%.

Jillian Taylor-Mancusi 02:26
Yes. There’s more than a few of those around.

Wayne Kay 02:30
Good grief. That terrifies me, just the thought of that.

Jillian Taylor-Mancusi 02:35
What the credit report is going to do is it’s going to tell your financial institution how much of a risk you are. And the credit bureau reports your credit history in two ways. The credit report, which is like a snapshot of your credit history, and that’s where you get that rating system between one and nine. And they usually have a letter in front of them, like an I, which means an installment or a car loan or an O, which is like a line of credit, an open credit, or an R, which is a revolving credit, like a credit card. 

You get between zero and nine, whereas zero means it’s too new, you haven’t really used it, or an R1, which means you have a great credit report and you pay within 30 days. You’re not more than a payment behind.

And then it can go to a R2 where you’re between 30 and 60 days past due, but you’re not more than two payments behind. And then it can really start to go down from there, where an R5, you’re over 120 days overdue, or an R7, which is like a settlement, or an R8, which is a repossession, all the way down to a 9, which is a bad debt. And a bad debt can include things like Bankruptcies, judgments, garnishments, or even if you moved and never gave them a forwarding address, it can give you an R9.

Wayne Kay 03:55
I didn’t realize that. I didn’t understand credit report versus credit score, which you’re going to explain later, but okay, so R9, bad – R1, good, right?

Jillian Taylor-Mancusi 04:06
Exactly. And you have to remember that not all places are going to report.

So like your utility bills, they won’t report or things like your cell phone bill, they’ll only report a late payment. They won’t report your good payments.

Wayne Kay 04:20
And credit cards, credit cards will report.

Jillian Taylor-Mancusi 04:24
And that’s the R, which is like a revolving credit. And the R1 to R9 really is how late you are paying.

So you don’t want to pay late because the later you are, the lower or the higher your number will get. So, if you are 120 days due, well, then you’re going to get an R4. If you are over 120 days, you’re an R5 and there are no R6s. So once you get past the R5, you start to get into settlements and repossessions and bad debts.

Wayne Kay 04:55
Who sees this credit report? Can I see it?

Jillian Taylor-Mancusi 04:59
Yes, definitely. Well, your own credit report.

Wayne Kay 05:03
Yes, exactly.

Jillian Taylor-Mancusi 05:05
So there’s two kinds of ways to look at your credit score, if you will, a hard hit, which is like if you’re going to apply for a credit card or a loan, versus a soft hit when you’re checking your own score.

Wayne Kay 05:18
Okay, it leads us into a credit score. Yes, that’s exactly what I wanted to know. I thought, before we jump into that difference between a credit report and a credit score – so the credit score is what?

Jillian Taylor-Mancusi 05:32
Also called like a FICO score or a Beacon score. And that’s the scale that people see between 300 and 900. So if you have 300 to 559, you have a poor credit score, and that goes all the way up to 760 and higher, which is an excellent credit score. 

And that’s where those hard hits and soft hits affect it. Because if you have a lot of hard hits against your credit score, well, that’s going to affect your credit score and start giving you bad marks. Whereas the soft hits, when you’re checking your own credit score, it doesn’t affect your credit score at all.

Wayne Kay 06:09
Okay, now explain that a little bit more now that I know that the credit score is different from the credit report. Hard hit. Soft hit, meaning soft is when you check your own credit rating out, right?

Jillian Taylor-Mancusi 06:22
And a hard hit is when you’re applying for credit. Now, again, they’re looking at the whole idea of risk management. So with a credit score, the higher your score, the lower the risk you are.

And there are different things that affect it. And again, it’s a formula based procedure where it’s based on things like credit history, how much you owe, the length of your credit history, whether or not you have new credit, what kind of credit you have. And it’s also interesting, here’s a little tip that your mortgage payments will appear on your credit report, but they won’t affect your credit score.

Wayne Kay 07:00
Oh, wow.

Jillian Taylor-Mancusi 07:01
So there’s a little tip.

Wayne Kay 07:03
Yes.

Jillian Taylor-Mancusi 07:05
And I also have another tip, actually. If you’re shopping around for the best mortgage rate or you want a really good deal on a car, every one of those is going to be a hard hit, right. So if you decide that you want to look for the best deal on your new car loan, try and do it within a two week period, because all inquiries that are made on that car loan or on a mortgage that are made in that two week period are usually treated as a single inquiry or a single hit.

Wayne Kay 07:36
Okay.

Jillian Taylor-Mancusi 07:36
The credit institution can tell that you’re looking around for the best deal, not that you’re really trying to get more credit for whatever reason.

Wayne Kay 07:45
I actually know of people, not just one, but I know of a few different people who have always just kind of paid cash for things and they take care of all of their payments. They even have houses that are almost paid off, bought their cars cash, and they have poor credit scores. And it turns out they’re missing one key thing that is really important, and that is credit cards. I had no idea how important a credit card is.

Jillian Taylor-Mancusi 08:15
Exactly, because those people that are paying cash, which is great for their own finances, is not good for their credit rating or their credit score. Now, if they’re the kind of person that can just walk into their local bank or their local credit union and apply for a loan and they know them because that’s the way credit unions and such work, not likely a problem. 

They know Joe Smith has a great financial record, great history, great assets. But if they’re going to apply to a big bank or for a loan through somebody they don’t know well, they’re not likely to get it because they’re going to have a poor credit score.

Wayne Kay 08:57
And that’s exactly what happened. They’d applied for something, a credit card, or I think it was one of the store credit cards and got declined because they said, I’m sorry, you just don’t have any credit for us to really engage this on. So what’s the best way for you to go about building your credit score?

Jillian Taylor-Mancusi 09:15
As much as I don’t like saying that because I’m a Licensed Insolvency Trustee, getting a credit card. Now if you’re somebody that doesn’t do well with credit because there’s people like that, they don’t really get that, you have to pay it back. 

You might want to do something like get a secure credit card. It’s like a debit card because you put your own money on it. But as soon as you make a purchase, it’s an instant repayment and it will report to the credit bureau the same way as a regular credit card would. But you never actually owe because it’s your own money. So that’s a really good way to start to build a credit score because it’s a really easy way to use a credit card.

Wayne Kay 09:55
And if you do find out that your credit score is low, how do you go about improving it?

Jillian Taylor-Mancusi 10:02
Well, there are things you can do, like don’t pay your bills late because like we talked about earlier, every time you’re late, you get a bad mark on your credit report. You can reduce the amount of debt you have because the lower your total indebtedness, the better credit risk you are.

You also want to make sure that you keep your credit cards down and you don’t use one to pay the others because that’s kiting and that becomes obvious to the lenders that you don’t want to do that. And like we said earlier about the hard hits, don’t make frequent credit applications because it’s going to negatively reflect your credit score.

Wayne Kay 10:38
Is there a number you need to keep it below every year? Because every time I go to a store, some store is offering me a credit card that if I sign up for this thing, I’m going to get 20% off, to which I’m continually saying, no thanks, I’d prefer to pay 20% extra.

Jillian Taylor-Mancusi 10:55
Right. And really that’s the answer. No, thank you.

Wayne Kay 10:59
Okay.

Jillian Taylor-Mancusi 10:59
Because you don’t want to have too many hits on your credit report. You don’t want to carry too many credit cards because even if you don’t use them all, it shows how much of a limit you have. You have that available credit.

So if things are going poorly and you end up going down the wrong path, you have a lot of available credit there. And that doesn’t look good to the financial institution either.

Wayne Kay 11:22
Is it bad to cancel a credit card

Jillian Taylor-Mancusi 11:30
Yes and no. You want to have some credit cards around so that you can have a credit report, but you have to look beyond just the credit report. Like I said, there are some people who just don’t do well with credit cards or they have a spending habit or an addiction problem. So sometimes you have to look beyond the credit card and see, is this too much of a risk for me to have this credit card? And if that’s the case, say no and cancel it.

Wayne Kay 12:01
But for myself, there is a credit card. We don’t use our credit cards very much now just for some points, but for the most part, never ever use a credit card. So we had two different ones or three different ones, and I was like, we don’t even use these. 

Why don’t we just get rid of this one that we never go into this bank at all? And somebody said, oh, no, you can’t do that. Your credit score will go down. So that’s why I asked that question. But it’s okay. I canceled it anyway. Totally fine. I didn’t need it.

Jillian Taylor-Mancusi 12:34
Remember, credit scores and credit reports are only important if you want credit, right? So if you already have your mortgage and a vehicle loan and you don’t need any credit, well, then it doesn’t really matter what your credit rating says anyhow.

Wayne Kay 12:50
And how do we find out our credit score?

Jillian Taylor-Mancusi 12:53
Well, in Canada, there’s two credit bureaus. One is called Equifax and one is called TransUnion. And they can both provide you with your credit reports and credit scores. Now you can do it by getting it through the mail, or you can do it on the Internet. Now it’s important to know that how you do it will depend on what you get.

If you get your credit report through the mail, you’re only going to get the credit report. You won’t get the credit score. Now, if you go on the Internet and apply for it, you can get both the credit report and the credit score.

Wayne Kay 13:27
Okay, so Equifax and TransUnion, the two in Canada, It’s totally safe to go online because I’ve seen some of these things where it says, hey, check your credit score. And I’ve always avoided them because I’m worried that some way, somehow, that, I don’t know, somebody will get some information from me.

Jillian Taylor-Mancusi 13:46
Actually, it’s a good idea to look at your credit report periodically just to make sure there’s no errors. They don’t have the wrong address or your name is misspelled. You don’t want to be applying for a mortgage or a car loan and find out that you got rejected because your name was spelled wrong on the credit bureau. 

And the other thing you want to check is to make sure that you haven’t been a victim of any identity theft. So are all the hits that are on there from you or somebody else using your identity and affecting your credit?

Wayne Kay 14:16
Yes. Well, that’s terrifying. And how often can you do this? Can you check it, like, every year?

Jillian Taylor-Mancusi 14:23
Oh, definitely. And like I said, it doesn’t affect your credit score if you do it yourself. So if you did it every six months or every year, then you can make sure that there’s nobody applying for covered credit on your behalf or someone hasn’t stolen your identity.

Wayne Kay 14:37
Right. Okay. Here’s another question for you: helping our young people build their credit. We have early 20s kids going off to school, and what should we do for them to help them build great credit?

Jillian Taylor-Mancusi 14:53
There’s a few things that they can do. One of my favorite things is to encourage your children to get RRSPs. Now, there’s a few things that an RRSP will do. It’s going to show the financial institution that they deal with that they can have a pattern of savings. So I know with my daughter, she gets $50 a month taken off right out of her bank account and puts it away for her retirement.

If, for example, they earn a lot of money. Having some of that money taken off and put into an RRSP is good because it will lower their taxable income and it can lower the amount of money that they owe at tax time, which is another thing my daughter has just learned about. Even though they might not understand that saving for retirement is important, she does understand that it lowers the amount of tax he has to pay the government.

Wayne Kay 15:51
Right. I just show them that final number when we play with the compound interest calculator, and I always talk about that on the show. Show them that number in 40 years and go look at what it can be.

Jillian Taylor-Mancusi 16:03
Yeah, exactly. Okay, so if they start early, they can retire with a pretty good bank account.

Wayne Kay 16:12
So RRSP also, I would assume, tax free savings accounts. That works as well. Yes, TFSA.  And what about giving them a credit card and letting me use credit cards?

Jillian Taylor-Mancusi 16:23
Yes, as long as you explain to them how a credit card works. Again, my daughter has a credit card with a very low limit, and she pays it off every month, and she understands that you have to pay it off every month because compound interest kicks in and you start paying a lot more money for things that you don’t pay off. 

So teaching them at a young age how these things work really influences how they’re going to grow and how they’re going to deal with things as they develop and become responsible adults.

Wayne Kay 16:55
Anytime you can teach our kids better spending habits, it’s something that will pay dividends to them in the future.

Jillian Taylor-Mancusi 17:01
Yes, exactly. It’s not too early to start when they’re, you know, kids, like under ten, even things like earning money from doing chores. And we would always joke that you get a chocolate bar and part of that goes to mom or dad or grandma or grandpa, and that’s the tax. So there are little ways of doing that that are kind of fun as well, but they remember.

Wayne Kay 17:25
I love it .Any final words of advice?

Jillian Taylor-Mancusi 17:27
Just remember you want to check it every once in a while. And you can do things like don’t pay your bills late, keep your credit cards down, reduce the amount of debt you have, and it can be important for things like future ability to borrow money or applying for a job or a rental application.

Wayne Kay 17:43
Yes, thank you very much. This has been a great show.

Jillian Taylor-Mancusi 17:46
Thank you.

Wayne Kay 17:47
You’ve got it. Always a pleasure chatting Jillian Taylor-Mancusi and to learn more, you can schedule a free consultation with LCTaylor Licensed Insolvency Trustee at the website lctaylor.com.

That’s it for today’s Debt Matters podcast. Make sure you subscribe wherever you get your favorite podcast from. And of course, for more information, you can always check out debtmatters.ca. Thanks for listening.