How does a credit score impact future borrowing?
A credit score is an integral part of your overall credit rating, and a good credit rating is extremely important when you want to borrow money. Lenders want to ensure that any money they lend will be repaid. Your credit score indicates to them what kind of risk they are taking if they lend you money; the lower your score, the higher the risk.
This risk determination then impacts a number of factors, for instance:
- How much a lender can lend you
- What interest rate a lender or financing company will charge you
- Which credit products you qualify for
- If there are any specific terms or conditions a lender will need to impose
If you have a lower credit score, restrictive terms or conditions can be baked into the type of product you qualify for, rather than a specific condition imposed by a lender. One such condition can be with regards to a credit card. Some card types limit how much of your credit limit can be used for cash advances versus normal purchase charges. Similarly, with consolidation loans some borrowers will need to consent for their lender to pay off and close paid accounts on their behalf; other borrowers may be allowed to do that themselves or even keep specific accounts open, with or without a reduced credit limit. Another condition a lender may impose based on your credit score is if you require security for your loan or not. If a lender is very concerned about a borrower’s ability to repay a loan, the lender will require a security that is as good as a cash equivalent, such as a non-registered GIC or term deposit, versus an item that first needs to be sold—for example, a car.
Your credit rating can impact broader financial activities
Beyond applying for new credit, your credit rating is also important to prospective landlords, employers and even insurance companies. While they don’t need your credit score if they’re not lending you money, they are among those who want to know how you manage your credit obligations. For instance:
- A landlord may want to know if you’re in arrears with previous utility bills or if you have a high car payment that could jeopardize your ability to pay your full rent.
- An employer may want to know how stable your financial situation is because when we have financial difficulties, our attention at work can be adversely impacted. For example, we might receive collections calls at work or if we’ve had a poor night’s sleep worrying about our bills, we could be distracted.
- Insurance companies may have similar concerns. For example, someone who doesn’t perform proper home maintenance because their budget is tight may file more property claims (such as a leaky roof or flooded drains). Car insurance providers know that someone who is sleepy, stressed and worried will be less attentive behind the wheel. Many insurance companies also provide payment plans for coverage, and those plans are a form of credit.
Managing our money effectively has countless benefits—financial, emotional, psychological and physical, to name a few of the biggest.
What can you control when it comes to your credit rating?
Credit cards can be useful tools when used correctly, so avoid falling for minimum payment myths, the biggest of which is that making minimum payments will get you out of debt. Instead, determine your own minimum payment based on your budget and goals. As long as it is higher than what your credit card statement shows, you’re doing yourself a big favour.
Take a look at these examples, based on the same debts from the chart above, to see how a higher fixed monthly payment will save you tons of time and buckets of money.
||Increase min. payment by…
||Your fixed monthly payment
||Years to pay it off
||Total interest paid
*The interest savings occurs when fixed monthly payments are made that are higher than minimum payments.