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How to build a credit score from scratch in Canada
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If you're working on building your credit score, you may be surprised to hear that you need to access credit to do so. But wait a second – don't you need a good credit history to access credit? The short answer is yet, and if it sounds a little confusing, don't sweat it! Let's start with the basics.
A credit score is a number between 300-900 that represents your creditworthiness and how likely you are to pay back credit. Your credit score is calculated by the credit bureaus – Equifax or TransUnion in Canada. The credit bureaus also produce a credit report, which is a detailed record of your credit history.
Having a good credit score can help you qualify for financial products like credit cards, loans and mortgages, and could help you get lower insurance premiums. So, taking the steps to build your credit score from scratch can be quite beneficial in the long run! Let’s dive into what you need to know.
How do I build credit as a newcomer to Canada?
As a newcomer to Canada, there are some steps you can take to start establishing yourself financially and building up your credit score. Here are three things you can do to start building your credit history.
1. Open a bank account
Opening a bank account creates a fresh credit file – or a clean slate, if you will. Plus, it allows you to build a relationship with your bank of choice. Usually, the longer you spend as a customer with a bank, the more products and services they will eventually offer you.
2. Get a cell phone
Getting a cell phone will also help establish your credit as a newcomer. Choose a cell phone provider that reports to the credit bureaus and make sure you pay your bills on time by signing up for automatic bill payments.
3. Use KOHO’s credit building
If you're new to Canada and don't have a credit history, it can be difficult to get approved for traditional credit products. KOHO's credit building allows you to take out a line of credit, repay it, and build up your credit history. You can choose an amount to set aside each month and we’ll report the amount as an on-time payment to Equifax to help improve your credit score. Also, when you download KOHO's app, you can track changes to your credit history to see how your score changes over time.
How do I start building credit as a young adult?
Building credit as a young adult may seem daunting. Between work, school, and planning for the future, your credit score may be the last thing on your mind. That said, learning about credit now and developing healthy habits to maintain your credit score will help set you up for the future.
A good credit score means you should qualify for the best credit cards and loans at favourable rates, which will save you interest on mortgage rates and insurance premiums. Here are our top tips to help you manage credit responsibly.
1. Create a budget
As a young adult, creating a budget – and sticking to it – is a critical step toward achieving your financial goals. Creating a budget allows you to look at the money you earn compared with what you spend. When you track your monthly expenses, you can prioritize setting aside funds for your loan or credit card payments before spending money each month.
2. Make your credit card payments on time
When it comes to maintaining a good credit score, making on-time payments is crucial. In fact, your payment history makes up 35% of your overall score. Missing just one payment can seriously impact your credit score, and each missed payment will lower your score even more.
3. Keep your credit card balance low
How much credit you use out of the total amount available to you makes up 30% of your credit score. Equifax recommends keeping your credit usage at less than 30% of the total credit available to you. Also, be sure to be mindful of your credit limits. If you use too much credit, it not only reflects poorly on your credit, but getting out of credit card debt is not easy.
4. Make more than the minimum payment
When you're tight on cash, it can be tempting to make only the minimum payment on your credit card statement. But, interest charges will add up, which will cost you more money in the long run, and could snowball into more debt. Paying off your balance each month in full can help you maintain a good credit score.
5. Be careful when applying for new cards
It seems like every store now carries their own credit card. As a young person, you will be marketed to with offers of credit cards from various institutions. The more credit cards you have, the more difficult it is to keep track of your payments. Also, every time you apply for new credit, your credit score will be impacted because the credit card company will check your credit first, also known as a hard credit inquiry. Unless you need new credit, steer clear.
How can I build credit with a credit card?
Credit cards can help you access credit and build your credit history. When you have a good credit score, you can opt for a credit card with cash back or rewards on every purchase. But before you graduate to one of those, let’s take a look at the different types of credit cards available to you when you’re building your credit history from scratch.
1. A secured credit card
Secured credit cards are a great way to build credit when you may not be in a position to apply for a regular credit card. While a secured credit card probably won’t provide any cash-back or perks, you are nearly guaranteed approval and it can be used to improve your credit score.
A secured credit card requires a security deposit up front, which typically acts as your credit limit but can vary on the credit card. As you begin to use your card, your payments will be reported to either Equifax, TransUnion, or both. Secured credit cards are helpful for people with damaged or non-existent credit because you’re almost guaranteed to be approved. Your security deposit acts as collateral, where with a traditional credit card there’s no deposit required.
2. A student credit card
If you're a college student or a recent graduate, you may be surprised to hear there are credit cards specifically made for you. As you know, using your credit card responsibly could help you build your credit score – like making on-time payments each month.
Student credit cards are a type of unsecured credit card, meaning, you don’t have to make a deposit. But, they do typically have lower limits than traditional cards. You may not even need to be a student to apply, so check with your provider to see what you could qualify for.
3. Credit cards for people with average credit scores
If you're working on your credit but it isn’t perfect yet – don’t worry. There are still many options available to you, and credit card companies have designed cards specifically for people with fair to average credit scores. A good starter card usually will have a lower limit and be easier to qualify for and may come with benefits like no annual fee.
What if I can’t get approved for a credit card?
With limited credit history, it could be a challenge to get approved for some types of credit cards. In that case, you have two options:
1. Become an authorized user
If someone gives you access to their credit card account, you can become an authorized user. As an authorized user, you receive your own card, but the original owner is responsible for making the payments. But, if the primary cardholder misses payments or uses too much credit, it can negatively affect both of your credit scores. When both parties use the card responsibly, being an authorized user could help build your credit.
2. Get a co-signer
You may be able to get your first credit card with the help of a co-signer, but not all credit card companies allow them. If you’re unable to pay your balance, your co-signer is responsible for them. Just like an authorized user situation, irresponsible use of a co-signed credit card can have dire consequences. Both you and your co-signer’s credit could be impacted if you miss payments, and your co-signer is obligated to pay back missed payments or even the entire loan.
Top tips for using a secured credit card to build credit
The important thing to remember when you’re building your credit history is that you do have options. If you’ve weighed those options and decided to opt for a secured credit card, we’ve put together some top tips for using a secured card to build credit.
1. Make timely payments
Pay your secured credit card bill on time every month. Payment history is a critical factor in building credit, and makes up 35% of your credit score. Consistently making payments when they’re due demonstrates responsible credit usage, and can help you graduate to a card with better perks.
2. Keep your credit usage low
Aim to use only a small portion of your available credit to keep your credit utilization ratio low. Ideally, you’ll want to keep your credit utilization ratio below 30% to show that you can manage credit responsibly.
3. Gradually increase your credit limit
As you build your credit history, you can see if you can inquire about increasing your credit limit. A higher limit can help you improve your credit utilization ratio and boost your credit score.
4. Regularly monitor your credit
Keep an eye on your credit reports and score to track your progress. Plus, keep an eye out for inaccuracies and report them to the credit bureaus if necessary.
How to transition from a secured credit card to an unsecured credit card?
In the perfect world, you’d be able to convert your secured credit card to an unsecured credit card with the same issuer. You should also get your deposit back and keep the account open, which will benefit your credit history. Unfortunately, not all issuers of secured credit cards have regular cards, but you can still apply for an unsecured card from another provider when your credit score improves. Once you're approved for your new card, and pay off the remaining balance, you’ll get your deposit back.
Pros and cons of secured credit cards
Not sure if a secured credit card is right for you? Luckily, there’s not much that a good-old-fashioned pros and cons list can’t fix.
Pros of a secured credit card
Credit-building opportunity: Secured credit cards are a great way to help people with damaged or no history build their credit scores. Regular and responsible use of a secured credit card will signal to the credit bureaus that you’re worthy of credit.
Accessibility: Secured credit cards are easier to qualify for compared to unsecured credit cards.
Credit limit control: Your credit limit is determined by your deposit, allowing you to control and manage your credit limit based on your financial capacity.
Learning responsible credit habits: Using a secured credit card provides an opportunity to develop healthy credit habits, like staying within your budget.
Cons of a secured credit card
Cash deposit requirement: To qualify for a secured credit card, you need to provide cash as collateral. This requirement ties up funds, and limits your available cash on-hand.
Potential fees: Some secured credit cards may come with various fees, like application fees, annual fees, and processing fees.
Lower credit limits: Secured credit cards typically offer lower credit limits compared to unsecured cards. This can impact your purchasing power, and could require more frequent payments to manage your credit usage.
Limited rewards and benefits: Secured credit cards generally have fewer rewards and benefits. While some may offer cash back or other perks, they may not be as lucrative as those available with unsecured cards.
Only you know your financial situation and can determine what option will work best for you. While a secured credit card is a great option, KOHO’s credit building allows you to work on your credit in a similar way. But, when paired with KOHO’s prepaid Mastercard, you’ll also get instant cash back on groceries and transportation, and up to 5% extra cash back when you shop online or in-store with our partners.
The bottom line
While it does take a bit of time, you have everything you need to build your credit history and ultimately improve financial well-being. A good credit history makes life easier, and having one is worth the patience required to improve it. But, what’s truly important is simply getting started on your credit-building journey.