Is your financial fate determined by a three digit number? In some senses, it is. A credit score (also known as a FICO or Beacon score) is a three digit number which all lenders will refer to before lending you money. Improving your credit score can result in sufficient cost savings over time. For example, according to FICO, if you improve your credit score from 660 to 760, the interest rates on a $216,000 30-year fixed mortgage drops from 6.5% to 5.89%.

However, keep in mind that all financial institutions use their own internal credit adjudication systems, in addition to your credit score, to determine whether to loan you money and at what rate. So a credit score given by a credit bureau is not the end all and be all. Regardless, given that a good credit score can literally save you thousands of dollars a year, it is within everyone’s interest to improve their score.

Since I started my own business, I have been extremely interested in finding ways to improve my credit score. Even if you run your own business, banks continue to lend money to small businesses based on the owner-manger’s credit history and not the business’. So being late on those student loans 5 years ago can come back to haunt you. It is not exactly fair but that’s how the game is played.

As the above shows though everyone has an interest in improving their credit score. I have attempted to summarize what I have learned (obviously, please don’t take this as gospel on the subject; I have tried to edit this down for brevity). A lot of this is common sense but aren’t all things about money?

Equifax and TransUnion are two large bureaus which collect your score. A credit score is a number between 300 and 900; the higher your number the better. A mortgage broker once told me that the highest credit score he has ever seen in 830. However, as the FICO link shows above, there are only marginal benefits once your score is in the 760’s and higher (my score is 799 as of last November). The reports can be obtained for free by law in Canada (although it takes a long time to get one for free).

I run a report once a year. The first thing I do is to make sure everything is correct. If there are any mistakes, I have to contact the lender first and not the credit bureau. It is not uncommon for people with common names to have wrong entries which belong to other people with similar names- so if your name is John Smith or Stephanie Johnson, you better check your credit score carefully.

Improving your credit score is a bit of a mystery in that there is no publicly disclosed formula that I have seen which says if you do “x” your score will increase by a set number. However, credit scores look at the following factors (as a side note, the score is determined by looking at each account- credit card, line of credit, student loan- you have open):

1. Payment History- the less late payments the better. In other words, ALWAYS PAY ON TIME. This is the single most important factor in increasing your credit score.

2. Debt to Credit Ratio- A debt to credit ratio is calculated by debt/available credit for each account you have open. For example, your credit card has a $2,000 credit limit; if you use $500 of it, your debt to credit ratio is 25%. The general rule is to have a ratio of less than 50% on each account. If your debt to credit ratio is high, your score will decrease (try to keep it under 35%). A large part of my score is attributed to the fact I have 5 credit cards but my debt to credit ratio on those cards collectively is 2%. This is generally the second most important factor in increasing your credit score.

3. Credit History- The longer your history with a creditor (assuming it’s a good history), the better your credit score.

4. What Type of Credit Account do you have Open?- The system discriminates against you if you have only one type of account open (for example, all credit cards). This factor tends to decline if you have a long credit history but for those who are just out of school, this is an important factor.

5. How Many New Accounts Do You Have?- The more accounts you open in a short period of time, the lower your credit score.

To keep this post relatively short, I have separated out part 2 of this post which I’ll post in an hour. Thanks.