What is a credit rating, and how does bankruptcy affect it?

We’ve all heard the term credit rating, and chances are pretty good that we know that our rating influences a bank’s decision whether or not to lend us money, give us a mortgage, and so on. But how many of us really understand what exactly a credit rating is, how it’s created, or how our financial situation can affect it?

For all of you who have had unanswered questions about the entire credit reporting system, we’ve put together a primer for you. Here’s what you need to know:

What is a credit rating?

Simply put, a credit rating is how a lender grades your ability to handle your debt with them. Lenders rate from a high of one when you always pay your bills within 30 days of their due date, to a low of nine when you don’t pay at all.

The type of debt is indicated by a letter before the number rating: an installment debt such as a car loan is “I”; an open debt such as a line of credit is “O”; and a revolving debt (the most common type) such as a credit card is “R”. So an R-1 rating would be given to a credit card debt you consistently pay on time. (You can find a complete list of R-ratings and their meanings on Industry Canada’s Office of Consumer Affairs’ website.)

What is a credit report?

The first time you apply for credit, a credit file is opened for you at one or both of Canada’s credit reporting agencies, Equifax and/or TransUnion. This file will go on to hold a complete history of your credit activities, including all your applications for credit (whether or not they were approved), and your repayment history, along with your credit ratings by each lender. A summary of this file is your credit report, which is what lenders will see when they request information on you from the agency.

You can and should review your credit report on a regular basis (at least yearly) by requesting a free copy from each of Equifax and TransUnion. If you find any mistakes on your report, such as information that doesn’t belong to you or debts still listed that you’ve paid off, you can request a correction. The Office of Consumer Affairs gives step-by-step instructions on how to do this.

What is a credit score?

A credit score represents a judgment about how good (or bad) a risk you are for lenders. Equifax and TransUnion both rate you on a scale of 300 to 900, with higher scores meaning a lower risk for a lender (indicating that you have a healthy credit history with other lenders). Individual lenders may also have their own rating systems in-house.

How does my financial situation affect my credit score?

All of your lenders make regular reports to Equifax and TransUnion about your debt repayment to them. Some behaviours can indicate that you’re in over your head financially and/or not otherwise dependable, and these will affect your score. Such things include:

  • falling behind on payments
  • having your utilities cut off because of lack of payment
  • maintaining high credit card and/or high credit line balances
  • making too many applications for new credit
  • having too many credit accounts
  • frequent job changes
  • frequent moves.

What happens to my credit rating if I declare bankruptcy?

Filing a consumer proposal and declaring bankruptcy both cause your credit rating to drop. A consumer proposal will be rated slightly better than a bankruptcy at R7 and will remain on your file for three years after you finish paying it.  A bankruptcy will be rated R9 and will stay there for about seven years. In the case of a second time bankrupt, it will stay there for about 14 years.

How can I rebuild my credit rating?

Rebuilding your credit rating isn’t a “quick fix” kind of thing, but it can be done. For helpful ideas on how to go about it, check out our 5 Steps to Rebuilding Your Credit Rating.

Where can I find help for my financial situation?

Remember, no matter how bad your financial situation may feel or how low your credit rating has fallen, it’s never too late to turn things around and get back on the road to financial health. To find out more about your options, call today for a free, no-obligation consultation with one of our insolvency experts: in Ottawa call 613-237-5555; out of town, call toll-free 1-800-517-9926 or book online.

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