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Credit Basics 101
Here is what they don't teach you in school!
  • Introduction
  • Equifax
Credit is a difficult thing to understand.  Most people have the basic concept that they either have good credit or bad credit.  What most people don't know is what makes their credit good or bad.  To the banks, credit is a measure of the probability of a loan defaulting should it be approved.  There are two credit reporting agencies in Canada.  Both measure a person's likey hood of fulfilling their credit obligations based on a complex algorithm to compute an overall score.  This calculation involves certain factors such as defaulted accounts, late payments on accounts, length of credit history, total debt load, percentage of balances versus limits, collection activity, foreclosures, judgements, bankruptcies, consumer proposals, and several other factors. The score that they generate will range anywhere from 300 to 900.  The higher the score, the more likely a person is to fulfill their credit obligations.   
Equifax is the dominant reporting agency in the western region of Canada and most banks rely on Equifax in making their credit decision. Equifax reports all the credit that you have and how it is paid on a monthly basis. These are called trade lines. Equifax will show payment history on each account for six years.  They will also show collections and foreclosures for six years from the date they were last active.  Bankruptcies will report for six years from the date they were discharged and consumer proposals will report for three years from the date they were satisfied.  They will retain credit inquires for the last three years but will also retain a minimum of five inquires on each credit file.  They retain both good credit and bad credit on file for six years.  All of this information will be calculated to generate an overall score.  Equifax calls this score a "beacon score".  This beacon score will change on a monthly basis depending on what information is applicable at the time.
  • Transunion
Transunion is the competing reporting agency to Equifax but just as important.  It is more dominant in Eastern Canada but some banks in the West do use it.  Transunion also reports credit with the same parameters as Equifax.  The major difference with Transunion is that good credit history will not disappear after six years as it does with Equifax.  Transunion will delete poor credit after six years but will retain good credit for twenty years. They also will generate a score based on all information on file called a "fico score".  Fico scores will also change monthly based on the information currently on file that month.  Based on the scoring system of Transunion and the fact that good credit is retained longer, a fico score will normally be higher than a beacon score for the same file.  
  • Types of Credit
  • Credit Scores and credit inquiries
It is important to understand the different types of credit, how they report, and how they impact credit score. There are four major types of credit:  installment credit, revolving credit, mortgage credit, and other credit. They are denoted on credit files with an "I" for installment credit, "R" for revolving credit, "M" for mortgage credit, and "O" for other credit.  Following the denotation, there will also be a number.  This number indicates  the current status of that tradeline.  
0:  account is too new to rate as no payments have yet been required
1:  currently up to date
2:  1 payment currently in arrears 
3:  2 payments currently in arrears and so on
7:  trade line was included in a bankruptcy or a consumer proposal 
8:  repossession (applicable on auto loans)
9:  account has been written off and in bad standing  

Installment credit refers to anything you obtain credit and have to pay it back in payments without the ability to re-use funds put towards the loan.  This can be an auto loan, a personal loan, or many other forms of borrowing that involve a structure repayment.  These accounts generally have more weight on impacting a credit score than the other forms of credit.  

Revolving accounts include any account that requires a monthly payment but remains open to withdrawn funds against it.  Commonly, these are credit cards and lines of credit.

Mortgage accounts are mortgages taken to purchase property.

Other accounts are forms of credit that don't fall into any of the other categories because they have no credit limit or no initial amount was advanced to be repaid.  For instance, some insurance companies will report to credit files using this category.  The most typical form of credit using this category is cell phone accounts.  
  • Types of auto lenders in Canada
Credit scores are the complex end result calculation of your overall credit worthiness.  They were created in the efforts of giving a simplified numerical overall risk score for someone to decide whether or not to grant a credit approval.  Credit scores are affected by credit utilization (how much you have owing versus what the limit is), number of trade lines, length on trade lines, missed payments, collections, foreclosures, bankruptcies, consumer proposals, and number of inquires to your credit file.  It is important to note that while all inquires to your credit file will be posted, multiple inquiries for the same type of credit product will affect the score exactly the same as one inquiry for that product.  For instance, if you were looking for an auto loan and three lenders looked at your application, it would be the same effect on score as if only one lender had looked at your application.  However, if you applied for an auto loan and then went and applied for a credit card, this would affect your score twice.  

While most of the time, credit score gives a good indication of the overall credit worthiness, it does however have certain flaws and draw backs.  Because score is heavily dependant on factors such as credit utilization , it sometimes does give a wrong overall picture of credit worth.  For instance, someone with only one trade line on bureau with a $500 limit and a $100 balance may have a much higher score than someone with multiple trade lines all paid well for a long time but fairly high on the balances versus the limits.  The credit score may indicate that it is safer to give the first person a big loan versus the other person who has well maintained all credit but has a high ratio of balances versus limits.  Some lenders derive most of their decisions based on this score, while most banks have another calculation they perform which involves this score but adjusts it to suit their allowable credit tolerances.  It is important to note that some banks do not even use the credit score in their credit adjudication decisions.    
There are two main types of auto lenders in Canada, prime and sub-prime lenders.  Although they fall under only two umbrellas, they all have different types of customer profiles that they prefer to approve.

Prime lenders are geared towards credit worthiness and work on a sliding scale of approval versus credit worthiness.  For instance, the stronger the credit, the higher the dollar amount they will advance.  Also, they offer low rates and longer repayment terms for a very flexible payment.  Generally, they will base their risk factor on credit score or some alteration of it.   

Sub-prime lenders recognize that credit may be challenged or non existent.  Because they expect more defaults on their loans, they charge higher rates.  These rates vary greatly depending on what credit challenges are present.  Also, all of these banks view credit differently so credit decisions will be vastly different from one lender to another.  It is because of the typically higher rate that these banks can afford to offer financing.  The idea is that even though they experience higher defaults rates, the other loans that do not default allow them to continue doing business and offer people a chance to obtain their loans and rebuild their credit worthiness.  
  • Understanding secured and unsecured credit
  • In-house financing
There are two ways to obtain credit.  When you apply for a home and are approved, the lender secures the loan with the property you have purchased.  This means should you default, the lender has the right to take away property and sell it to recover as much proceeds as possible up to the amount owed on the loan.  Because of this, lenders recognize that they are partially protected and lower both their qualification criteria, as well as the interest they require on the loan.  It may still involve a certain amount of credit worthiness, but requires less credit worthiness than qualifying without the security.  

Unsecured loans are loans that are given without anything being used as collateral.  Unsecured loans are a higher risk for lenders as they realize that if the loan is not repaid, they have no recourse other than reporting a bad loan status to your credit file.  Because of this, credit qualifications become harder, and interest rates are higher.  For instance, going to the bank and asking for a personal loan to purchase a vehicle would typically be a higher rate than if you obtained financing at the dealership via the same bank.  Overall, it is also harder to qualify for an unsecured loan versus a secured loan.  

Lenders may often at times offer lower rates and lower qualification standards for one form of credit by securing it to another.  A good example is using your low interest home equity line of credit to purchase a vehicle.  Even though you are able to obtain low interest financing for your vehicle, attaching the home as security is a very risky proposition.  In the unfortunate case that you are unable to meet financial obligations, you risk keeping your car but losing your home.  In the other case where the auto loan was secured with the vehicle, if you can't fulfill your financial obligations on the vehicle, the only thing you would lose would be the vehicle.  
  • Bankruptcy and Consumer Proposal
In-house financing refers to when you purchase a vehicle and the dealer lends you the money for it.  Essentially, the dealer becomes the lender.  Although this may be handy in some instances as the dealer will have a vested interest in advancing you the loan, there are a few things that you need to be cautious of.  The dealer is not bound to any type of credit adjudication parameters and hence can decide to give you whatever interest rate they choose.  This may result in paying more interest than required based on your individual profile.  More importantly, dealers do not report to the credit bureau.  As you fulfill your repayment obligations, you do not improve your credit on bureau and retain your current credit profile.  You may be able to receive a lower rate from that dealer on your next vehicle purchase but the end result is being obligated to purchase at one place.  
There are many misconceptions about bankruptcy and consumer proposal.  Many people believe that one form of this insolvency will impact their credit less severly than the other.  Part of the reason is due to the fact the agencies providing these services are for profit agencies.  As their revenue is derived from a portion of the monthly payments required while in these programs, their advice may be a little biased.  Regardless of how agencies market both of these programs, lenders view both programs in exactly the same way.  The difference between the two programs is the terms of completion.  

Bankruptcy is the declaration that you are no longer able to pay your creditors.  It is a federally regulated process through individual agencies.  Depending on your income, entering bankruptcy is either a nine month process or a twenty-one month process.  In either case, you are required to pay a base monthly payment to your trustee (the person overseeing your bankruptcy) as well as 50% of any excess income over their allowable limits.  After your time obligation and monthly payment obligation have been achieved, you will then be discharged from any further credit obligations.  The bankruptcy will remain on the credit bureau for six years from the discharge date.  
Consumer proposal is the process of offering your creditors a certain percentage of your debt to be paid back over a negotiated period of time.  This process is also facilitated through the same agencies.  Consumer proposal remains on the credit file for three years after the obligations are met.  Although consumer proposal remains on the credit file half the time of a bankruptcy, it is important to consider that the time required to pay back the acceptable percentage may result in consumer proposal affecting you longer than a bankruptcy. For example, if you are in bankruptcy for nine months and discharged, your credit file will be affected by a total of six years and nine months.  Alternatively, if you opt for a consumer proposal that requires payments over a five year span, your credit file would be affected for a total of eight years.  

Regardless of which option is chosen, banks view both with the same regard.  However, sub-prime lenders favor clientele who have been through this process for two reasons.  Firstly, all other debt obligations are satisfied.  The lender does not have to worry if you will choose to pay the credit card as opposed to the auto payment when you have insufficient funds at your disposal.  Secondly, after going through this process, most people are careful not to fall into old habits again that got them to the point of bankruptcy.  They become very financially responsible and that results in lower risk for the lender.  
  • Rebuilding Credit
When lenders adjudicate credit, they are looking to answer the question of if they will be repaid on the funds advanced.  When they see that someone is struggling with their current obligations it causes concern.  The first step is to catch up on current financial obligations or if that is not possible, to consider bankruptcy or consumer proposal.  Once that is done, it becomes a much easier process.  Thinking of credit as stepping-stones may be the best analogy.  Taking a loan on a security such as a car is one of the best ways to start.  As payments are made, your credit profile improves and opens more options for you.  As this happens, it gives you the ability to trade in the vehicle into another one at a reduced rate.  It also gives you the ability to be approved for other forms of credit like credit cards and lines of credit.  Rebuilding credit is a very easy process but takes time.  It involves dealing with your past obligations, acquiring new credit and proving the ability to meet the financial obligations agreed to.
  • ​​The importance of dealing with the right approval representative
Every credit profile is different.  Every lender has different lending parameters and practices.  An approval representative needs to understand both your credit situation and which lender will look most favorably upon it.  Without this know how, you may still be approved but at a higher interest rate.  Worse yet, you may not be approved at all as the representative does not have the skill set to argue properly on your behalf.  Because there is no training or certification requirement for someone to become an approval representative, you need to be careful on who you choose.  Make sure you trust them and what they say makes sense to you.  Most importantly, make sure they have the experience to properly represent you and your credit worthiness.