Are you looking to rent a new home? What about applying for a loan of some kind? You’ll need credit references for those goals. Don’t worry, credit references are not as intimidating as asking your manager to be a reference for another job, or requesting a professor write you a reference letter. Let’s break it down to get you on your way to financial fruition.
What is a credit reference?
A credit reference is like a reference for a job but for your finances. Basically, it’s a document that details your credit history. These references are most commonly used when applying for a loan, or to support a rental application. Banks, landlords, and other companies use this document to gauge how likely a person is to repay what they’ve lent you, or how likely you are to pay your rent on time.
Having a good credit reference is beneficial. If a potential bank lender or landlord is considering you, a credit reference shows a record of how you’ve paid your debts and bills in a timely manner. With good credit references, they’ll be more likely to consider your application.
What are the components of a credit reference?
There are several different documents at your disposal that can be used in a credit reference, depending on your situation and goals.
Credit history: This is the most common kind of reference you’ll come across on your credit journey. It is a detailed report that compiles information about repayments for all your debts from a number of sources. This could include credit card companies, banks, governments, as well as others, like utility providers. Your credit history may also include your credit score, which is a number that is calculated from your history to determine how likely you are to pay your financial commitments in full.
Payment behavior: This term describes the nature of your payment habits, based on a historical record of your payments. An analysis of your payment behavior is used to calculate the credit score that appears on a credit history report. Your payment history accounts for 35 per cent of your credit score, so even if you are making minimum payments on your credit cards, that can have a positive impact on your score over time.
Outstanding debt: This is the total principal amount of debt that still needs to be paid on an outstanding loan. This number will also include accrued interest that has been collected on the debt over time. Lenders will consider this number before providing the services you request. To calculate it, add the sum of your short and long-term liabilities.
Credit limits: A credit limit is the maximum amount of credit that a bank, financial institution, or other lender is willing to extend to a client on a particular line of credit. These ceilings are typically put into place on a credit card or line of credit.
Loan history: When considering a client for a loan, financiers may look at how someone has handled their loans in the past. Your loan history is a record of the loans you have taken out, and how many times you have made payments, or opened new lines of credit. All of this information may be included in your credit reference to show that you are a trustworthy candidate.
Public records: Records that are accessible by the public, like a bankruptcy, or a loan backed by property as collateral, may be part of your credit reference. Credit-related judgments in certain kinds of lawsuits may also be included as a reference.
How to obtain and interpret credit references
Different institutions will have different requirements for the types of information you will need to include in a credit reference. Set yourself up for success to be the best candidate by verifying what you need so your application process goes as smoothly as possible.
First, you will most often need to request a credit report from a credit bureau. Equifax, Experian, and Transunion are the three major bureaus in Canada. Most Canadian credit bureaus buy their credit information from FICO, a U.S.-based data analytics company focused on credit scoring services.
Equifax allows you to access your credit report and score online for free and updates them monthly. You can get a free credit report from other institutions, but they may only detail your financial history. You may need to pay a fee to these companies in order to access your credit score. Additionally, Many banks offer in-house “soft” credit score assessments that you can access in their mobile applications to ensure your score stays healthy over time.
You may also be required to ask your previous employers, landlords, and creditors to provide reference letters. Once they accept, send them a letter template and the formatting requirements of an application. It is also wise to include a deadline to ensure you aren’t down to the wire on submitting your documents for consideration. You will need to supply written authorization to your previous service providers to release your information to lenders, who may also contact your references to verify the information.
The person or institution analyzing your credit references will take into consideration how responsibly you’ve handled your financial obligation in the past. A credit score is a number that summarizes this analysis based on all your past payments. If you have a good credit score, you can highlight this on a credit reference
Why are credit references important?
For an individual, a credit reference is important because it is used to determine how financially trustworthy someone is, this is called creditworthiness. Because a lender is taking on a financial risk when considering your applications, they use creditworthiness as a measure of how likely a person is to default on their outstanding obligations to a lender.
If you have a bad credit score, all is not lost. There are lots of ways to manage and improve your credit references. The first step is knowing what parts of your financial behaviour are having an impact on your credit score. How long you’ve carried a balance on your credit cards, and how often you’ve missed payments may be contributing to a low score.
To improve your creditworthiness, make sure you always pay your bills on time and only take out the credit you need. Budget wisely and work to build your savings to create a financial safety net. In case of a financial emergency, you can pull from your savings instead of relying on credit, which can lower your score. Want to get serious about improving your score? KOHO has a credit-building tool that helps Canadians build their credit for only $10 per month.
Credit references are also essential for evaluating the financial health of a business. You may need to supply more than your credit report in certain instances. Often, you may need to provide documentation of assets, which signal your financial health. This can include cash, properties, and even investment accounts. These may be considered as collateral, which is encouraging to lenders. Personal character references are also frequently used.
Why are credit references important for loan applications?
Credit references play a primary role in any application process for a loan. Your references influence the decision made by a financier on a loan. Each part of your reference helps to determine how trustworthy of an applicant you are to the bank or creditor that is considering you for a loan. Some lenders may only take your credit score into consideration. For those who consider a more robust application, you will want to ensure all parts of your reference are as positive as they can be.
It’s important to establish strong references, as a declaration of your good character by former employers, landlords, as well as family and friends, can influence you positively on your financial journey. However, unlike a co-signer or guarantor, people who provide references are not bound by your credit approval themselves.
How do I maintain good credit references?
There are several best practices you can employ to maintain and strengthen your credit references. Maintain good relationships with your current landlord, employer, and other service providers. Longevity in these relationships contributes positively to your creditworthiness.
It seems obvious, but paying your bills on time, every time helps avoid losing points on your credit score. You can take all the hassle out of monthly payments by setting up automatic withdrawals. Finally, only apply for the credit that you need. Lenders don’t like to see that you carry balances on multiple credit cards, as it suggests you may be spending more than you can afford to.
If your credit score is lower than you are comfortable with, you have the power to improve it. In the short term, if your low score is because of circumstances beyond your control, like losing your job or illness, you can supply documentation of this to inform lenders or landlords of your situation. The more transparent you are, the more likely you are to be considered.
Most importantly, don’t lie. All the information listed on your reference can be checked independently of you. Falsifying information won’t improve your chances in the slightest.
How do I respond to credit references?
If your request is denied, it’s possible that there may be inaccuracies or discrepancies in your reference. You may want to consider checking each component of your reference to ensure all your information is correct. Even worse, odd errors in your credit references may also indicate that someone is trying to steal your identity. Even if you are not applying for any new kinds of credit, it’s important to check your information annually to prevent identity theft. This is as simple as ensuring your address and date of birth are accurate.
More broadly, negative financial information, like how you handled your credit cards in your early 20s, can only stay on your credit report for six years. For credit checks by lenders, Equifax keeps your information for three years, while TransUnion keeps it for six. Something more serious like bankruptcy will stay on your report for six or seven years, depending on the province.
Even though it sounds intimidating at the outset, with consistency and effort, you can improve your financial portrait, and get the credit references you need to meet your goals.
Morgan Sevareid-Bocknek is a Toronto-based journalist. She is an investigative reporter at the Toronto Star and has reported for The Associated Press and The Globe and Mail.