The following is a guest post by request. How important is credit when building wealth? Here’s the answer, with some useful tips courtesy of the team at Loans Canada.
When it comes to personal finances, credit is probably a term you’ve seen bouncing around. You might be wondering, is credit really important when it comes to building wealth? The answer to that question is yes, but credit contributes to wealth indirectly. Building good credit helps individuals establish good financial habits and access top of the market financial products. Both of these things are crucial when it comes to building wealth.
Understanding Your Credit
A credit score is a number that communicates your creditworthiness to lenders and other interested individuals. Before diving into how credit can affect wealth building, it’s crucial to understand how credit works and what factors influence it. There are five main factors that are used during the calculation of your credit score.
How Credit Scores Are Calculated
- Payment History (35%): How you’ve managed debt in the past is the largest contributing factor to your credit score. If you’re good about paying bills on time, you’ll do well in this category and likely have decent credit.
- Current Debt Levels (30%): While taking on and responsibly managing debt plays a huge role in building credit, but carrying too much debt is not good. Specifically when it comes to credit card debt. When building healthy credit, it’s important that you don’t use more than 30% of your available credit limit, as this is will negatively affect your credit utilization ratio.
- Credit History Length (15%): The amount of time you’ve been managing debt is considered here. Having a long credit history is ideal because it provides a more accurate financial history.
- Credit Diversity (10%): How many different types of debt you’ve managed are considered in this category. Every type of credit has different repayment terms and conditions, managing multiple shows you can handle your finances well.
- Credit Inquiries (10%): A credit inquiry occurs every time someone pulls your credit report. When you pull your own credit report, there will be no impact. But, when someone else pulls your credit report, such as a lender or bank, it will negatively impact your credit score. Having one or two inquiries is fine, but more than that can indicate financial stress.
What Information is Included in a Credit Report?
In addition to the above, the information on your credit report can also affect your credit score:
- Identifying Information. Full name, addresses, SIN number, date of birth, and phone numbers. If any of this information is incorrect, it could be negatively affecting your score.
- Public Records. Any public record items that would impact your creditworthiness is considered here, such as judgments or bankruptcies.
- Collections. If any of your debt has gone into collections, it will appear on your credit report.
How Good Credit Can Help You Build Wealth
Good credit doesn’t directly build wealth, but it is certainly a powerful tool that will enable you to build wealth. Generally speaking, when it comes to building wealth, you can use your good credit in one of two ways; by leveraging it to borrow or to save.
Leveraging Your Good Credit to Borrow
- Becoming a homeowner. Purchasing a home is one of the most popular ways to invest and build wealth. Healthy credit is an important part of becoming a homeowner and securing a mortgage from a bank with an affordable and competitive interest rate. A mortgage can be a great vehicle to help save and build wealth for retirement, with the end goal to sell your house for a significant profit.
- Becoming a property owner. Just like becoming a homeowner requires healthy credit, purchasing any additional properties relies heavily on your creditworthiness. Purchasing a rental property is a great way to build a passive income and help you increase your wealth over time.
Leveraging Your Good Credit to Save
- Qualify for low-interest rates. It is a known fact that good credit means low-interest rates. When borrowing, low-interest rates are crucial because it means the money you borrow will be more affordable and allow you to save more of your after-tax income. Saving more means you’ll have more money to invest in other fruitful opportunities which can help you build more wealth.
- Better insurance rates. Insurance companies frequently consider your credit score and report before extending rates. Good credit will ensure you get an ideal rate which will again help you save more money.
Creating wealth is a long term project and not an overnight decision for the majority of Canadians. Building a healthy credit history should be a part of this journey. Not only can good credit afford you the opportunity to borrow to invest, but it can also allow you to save, which is ultimately how many consumers are able to build wealth over time.
Dale note …
Thanks for reading. On a personal note, good credit and borrowing was very important in our wealth building process. Our real estate (homes) has been a terrific investment.
And when building credit you can help build wealth. We make about $600-700 annual with our Tangerine Cash Back Credit Card.
For any questions please use that contact form. You can find some great information on a variety of topics on the Loans Canada blog.