How do credit scores work

Dated: March 3 2021

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There are several reasons why you would want to check your credit score. You might be looking to buy a car and want to know what your options are when it comes to financing. You might be thinking of buying a home and need to know where you stand when it comes to getting a mortgage. Or you could just be curious and want to make sure that nobody’s stolen your identity and taken out credit in your name. Whatever the reason, checking your credit score periodically is a good idea to stay up-to-date on the current state of your credit health. More on that below. In case you didn’t know, checking your credit score can be done quickly and conveniently these days. With a quick search online, you’ll be sure to find some companies that can help you check your credit score for free.  If you’re already in the habit of checking your credit score, you may notice that despite little changes in your life, your credit score fluctuates, seemingly at random. Rest assured this is quite normal. We’ve written this post to explain why this happens so you can get a better idea of what’s occurring “behind the scenes” with your credit score. Below are some of the scenarios that could lead to a rise or fall in your credit score – besides the obvious reasons, like declaring bankruptcy. Keep in mind these are just some of the possibilities, there may be others that aren’t listed here.

1. Your credit score changes because your credit history is changing

Whenever you make payments on your credit accounts like your monthly car payments, credit card payments, or mortgage payments, this changes not only the balances on those accounts, but it changes the payment history on those accounts as well. The same thing happens if you miss one of those payments but in the opposite direction. Payment history has a significant effect on your credit report, which in turn affects your credit score.

2. Your credit utilization is also changing

Similar to the above scenario, changes in your credit utilization play a major role in your final credit score. Credit utilization is basically your debt-to-credit ratio or the amount of debt you have divided by the amount of credit available to you. So if you open a new credit account and don’t use it or start relying more on a credit card or line of credit, your credit utilization changes, changing your credit score.

3. Closing a credit account

While most of us think that paying off a credit card and closing the account is a good thing, doing so may cause a dip in your credit score. Not only does closing a credit account lower the amount of credit available to you and therefore your credit utilization rate, but it also deletes all that valuable credit history you built up with months of on-time payments. You may want to consider keeping the accounts open and using them periodically to make sure the lender doesn’t close the account due to inactivity.

4. Simply applying for a credit account

Doing a simple check on your credit score doesn’t affect it. This is what’s known as a “soft inquiry”. If, however, you’re actually applying for a credit product like a new credit card or a loan, this may affect your credit score negatively. This is known as a “hard inquiry”. If you’re shopping around for the best rate on a loan or mortgage and filling out multiple applications, as long as they’re done between 7 and 45 days of each other, they should only count as one inquiry. The same is not true for credit card applications, however, and each one will count as a new inquiry.  It’s usually a good idea to do your homework before filling out multiple credit applications anyway and with the easy availability of your credit score and plenty of information on different lenders and their rates online, you can save yourself a lot of time and legwork.

5. Differences in credit scoring

Depending on who’s reporting to the credit bureau, and which credit bureau they’re reporting to, your scores may end up being different based on those factors alone. For example, different industries, like credit card companies versus car loan companies, may have different ways of calculating your credit score. Sometimes even different companies in the same industries could have different scoring models. Add that to the fact that they may only report to one of the two Canadian credit bureaus (Equifax and TransUnion) or neither, and that the credit bureaus themselves can have different scoring models, you can see why your score changes or is different despite you not changing your payment habits.  If you do notice that your credit score is changing, it’s important to make sure it’s not happening because of fraud or reporting errors made by a lender. Checking your credit score and credit reports regularly is a good way of monitoring your credit health and staying on top of your finances. 

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Roger Flowers

Roger Flowers is a professional real estate agent with eXp Realty and has been a licensed agent since 2001. He believes a Realtor is in the service industry, not high-pressure sales. As a Realtor, he ....

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