Consumer Credit

What is credit?

Credit refers to financial products that allow you to borrow and use funds that you repay later. There are different types of consumer credit products; they’re divided by two basic distinctions.

Installment vs Revolving

With installment credit, you borrow a set amount in a lump sum that you pay back with fixed payments. This includes:

• Mortgages
• Car loans
• Home equity loans
• Student loans

With revolving credit, a creditor extends you a line of credit that you can borrow against as needed. You only make payments based on the amount of the credit line you’re using. This includes:

• Credit cards
• Lines of Credit (LOCs)
• Home Equity Lines of Credit (HELOCs)

Secured vs Unsecured

The next distinction is whether the credit is secured with collateral or unsecured. Secured requires collateral, which is a tangible asset that a lender can take if you fail to pay back a loan. This includes:

• Mortgages, secured by the home purchased
• Car loans, secured by the car purchased
• Home equity loans and HELOCs, secured by your primary residence
• Secured credit cards, secured with a cash deposit

Unsecured credit doesn’t require collateral. The lender extends you credit in good faith that you will pay it back. This includes:

• Student loans
• Personal loans and LOCs
• Unsecured credit cards

Just because unsecured credit has no collateral, it doesn’t mean there is no cost. We’ll detail that next

The Cost of Credit

Consumer credit creates personal debt. You pay back not only the money you borrow or use (known as the principal) but interest charges and fees as well.

Fees

Loans and credit cards almost always come with added fees. There are fees to cover the costs of applying for a loan, such as loan origination fees. Some credit cards have annual fees, that you pay each year just to keep that card open and active. There are also fees for conducting certain types of transactions:

• Balance transfer fees apply when you move a balance from one account to another.
• Cash advance fees apply when you take money out using your cards at an ATM.
• Foreign transaction fees apply when you make a purchase abroad.
• Over limit fees apply when you go over your limit on your credit card with a purchase
• Overdraft fees apply when you spend more than you have in your bank account

Then there are also late fees that a creditor or lender will apply immediately if you miss a payment due date.

Interest charges

Creditors and lenders apply an interest rate to your balance each billing cycle. This adds a percentage of your balance to what you owe each month. When you make a payment, part of the money gets used to cover accrued monthly interest charges. Higher interest charges take up more of each payment, which slows down how fast you can pay off the principal debt.
The interest rate on a loan or LOC will usually be expressed as an annual percentage rate or APR. For loans, APR includes the annual interest rate plus some fees required for getting the loan. For credit cards, the annual percentage rate is equal to the annual interest rate (AIR) on the account.

How to keep costs low

Your goal should always be to keep the cost of using credit as low as possible.

• Look for loans that offer no origination fees
• Always ask to see a list of fees before you apply for a loan
• Compare fees and APR when shopping for loans and credit cards
• Avoid cards with annual fees
• Pay off your credit card balance in full every month to avoid applied interest charges
• Consider refinancing loans if you can get lower APR, but be aware you may pay fees to refinance

Maintaining a clean credit profile

As soon as you start to use credit, you begin to build a credit profile. Consumer credit profiles are made of up two components:

1. Credit reports
2. Credit scores

Lenders and creditors review your profile anytime you apply for new credit. Your profile shows them how responsible you are with credit and how likely you are to repay a debt. This is also known as creditworthiness. A strong credit profile shows you’re a good candidate to get new credit and favourable terms. A weak profile indicates you are a high-risk borrower that may be likely to default.

Your credit report

A consumer credit report details your history as a credit user. It includes information about current and even past credit accounts, including:

• The status of each of your accounts
• Payment history, going back seven years on active accounts
• Current account balances
• Public financial records, such as collection accounts, court orders and insolvency filings

When you miss payments by more than 30 days, settle a debt for less than you owe, or allow accounts to be sold off and sold to a third-party debt collector, it creates negative items in your credit report. These are red flags to creditors and lenders because they show you’ve had trouble with debts in the past.
There are two credit reporting agencies (bureaus) that maintain consumer reports in Canada: Equifax and TransUnion. Each agency maintains its own version of your report, which means every consumer really has two reports, even though they have just one credit history.

How long does negative information stay on your credit report?

The good news is that nothing on your credit report lasts forever. There is no negative information that remains on your report indefinitely, even bankruptcy and foreclosure notations eventually fall off your report. Even positive information, such as accounts you’ve maintained in good standing, will only stay on your report for about ten years once they are closed.
Most negative items on your credit report will fall off your report in seven years or less. Missed payments, negative account notations like charge-offs and collection accounts will stick around for seven years.
When you enroll in a debt management program with New Leaf, it will be noted in your credit report. All of the revolving debts in that you include in the plan will have an R7 status notation. This shows that the debt is a revolving debt (R) that you’re paying back on an adjusted payment schedule. This status will remain on your credit report for two years after you graduate from the program.

Your credit score

In addition to your report, consumers also have a credit score. This is a three-digit number that uses the information in your report to rate you as a credit user. A high credit score shows you have a long and stable credit history. With a high score, creditors and lenders will be more likely to approve you for credit and extend favourable terms, such as lower APR and higher credit limits.
By contrast, a bad credit score shows that you’ve struggled with credit in the past. Lenders will only extend credit to you with restrictive terms if they approve you at all. Bad credit can hold you back from achieving your goals. It also means you’ll pay more for the credit you use because of higher interest rates.
Many companies have credit score models that they use to rate you, including the credit bureaus themselves. FICO is the most widely used score in North America. In Canada, it ranges from 300-900. Your score is calculated based on five factors:

Credit history (35%) – How likely are you to pay?

The biggest factor used to calculate your score is your credit history. This looks at the payment history and any status notations applied to each of your accounts. Maintaining a clean credit history with current account statuses and no history of missed payments is the best thing you can do for your credit.

Credit utilization (30%) – How much credit are you using?

Your credit utilization ratio looks at how much debt you currently hold. It does this by comparing your current balances to the available limits on revolving lines. Let’s say you have a $5,000 limit on a revolving account and you currently have a $1,000 balance. That puts your utilization ratio at 20 percent.
Creditors like to see that you’re using 30 percent of your available credit or less. People often think you need to carry balances to maintain a good score but paying off all your debt every month maintains the best possible utilization – zero!

Credit “age” (15%) – How long have you used credit successfully?

Creditors and lenders want to see that you’ve used credit successfully for as long as possible. Credit age establishes the length of time you’ve used credit, showing how experienced you are at paying off your accounts.
To positively influence this scoring factor, you need to maintain accounts in good standing over a period of time. Closing old credit card accounts that you no longer use can unintentionally hurt your score.

New Applications (10%) – How much have you applied for credit recently?

Creditors and lenders also want to know how many credit applications you’ve had in the recent past. They do this by checking the credit inquiries on your credit. Inquiries happen anytime someone checks your credit. There are two types of inquiries:

• Soft inquiries happen when creditors and lenders screen you for pre-approved credit offers, business credit checks, as well as when you check your own credit. These don’t affect your score
• Hard inquiries happen when you apply for credit and authorize the financial institution to run a credit check. These can negatively affect your score.

Too many hard inquiries on your report look bad because it means you’ve potentially taken on a lot of new debt at once. Inquiries may stay on your report for up to 3 years. Try to space out applications to avoid hurting your score.

Types of credit (10%) – Do you have a diverse range of debt, specifically good debt?

Finally, creditors and lenders look at the types of debt you have. They want to see you have experience managing a diverse range of debt. This includes installment loans, as well as credit cards. Certain debts, like mortgages, are also considered “good debt.”

Tips for rebuilding your credit

When you face challenges with debt, your credit can take a hit. Everything from high credit utilization and missed payments, to negative account statuses and collection accounts, can hurt your score. Some of the penalties you’ve incurred may stick around for years. But the good news is that you don’t need to wait for those penalties to expire to start rebuilding your credit.
The impact of negative information in your report on your score decreases over time. Even before the penalties expire, their “weight” to negatively influence your score decreases. And you can offset that negative information by taking positive actions for your credit now:

• Pay all your bills on time – this is the best (and easiest) thing you can do!
• Don’t use more than 30 percent of your available credit – less is always better!
• Be positive that you can afford to repay a debt before you take on new credit.
• Apply for credit sparingly – space out applications by at least six months
• If you have accounts you’ve managed to maintain in good standing, keep them open
• Don’t just focus on credit cards – loans, especially mortgages, are a good credit indicator.

Repairing errors on your credit report

It’s important to review your credit reports regularly to check for mistakes. Reporting errors happen, including:

• Outdated account statuses
• Inaccurate payment history
• Duplicate accounts
• Old collection accounts

These mistakes can hurt your score, so once you identify them, you need to take action to correct them. You must contact the credit bureau that reported the information or the creditor who provided it. Provide the account number, then explain how the information reported is inaccurate.
Here are some helpful links if you decide to dispute the information directly with the bureaus:

• File an Equifax dispute
• File a TransUnion dispute

Avoiding credit risks

Using credit invites two big risks:

1. You can be the victim of identity theft and credit fraud
2. You have a higher risk of facing financial hardship

There are steps you can take to minimize these risks. Here’s what you can do:

Protecting against identity theft and credit fraud

One of the most common forms of identity theft is credit fraud. This involves the unauthorized use of a credit card. This can happen when someone steals your account information and starts making purchases or taking out cash advances on your card. Someone may also get your social insurance number and open new accounts or loans in your name.
These tips can help you protect your accounts, data and personal information:

• Always make sure to keep your credit card information secure
• Only shop online on secured websites
• Sign up for the free fraud protection on your accounts and respond to alerts promptly
• Change passwords often on all your financial accounts
• Do not send sensitive financial information via email or text.
• Don’t respond to unsolicited requests for your financial information.

What to do if you’re a victim of identity theft

1. If the theft involves a specific account, contact that creditor immediately.
2. File a police report.
3. Notify the credit bureaus that you need to place a fraud alert on your report.
4. Contact the Canadian Anti-Fraud Centre by calling 1-888-495-8501 or going online at https://www.antifraudcentre-centreantifraude.ca/

Avoiding financial hardship caused by credit

While you’re enrolled in a debt management program with New Leaf, you won’t be able to use your credit cards or apply for new ones. Once you graduate and become debt-free, it will be up to you to decide if you want to use credit cards again.

• Regardless of what you decide, these tips can help you stay credit-healthy.
• Recognize that you don’t need credit cards to maintain a high credit score; you can maintain a good profile, even if you only take out loans.
• Always make sure you can comfortably afford the payments on installment credit before you apply.
• Don’t use revolving credit to cover daily expenses. This is a recipe for financial hardship!
• If you use credit cards, the minimum payments should never exceed more than 10 percent of your monthly income. If you start to spend more than that, stop charging and focus on debt repayment.