What is bad credit?
Bad credit refers to a person’s history of not paying their bills on time and the likelihood that they will fail to make timely payments in the future. This often results in a low credit rating. Businesses can also have bad credit depending on their payment history and current financial situation.
A person (or business) with bad credit will find it difficult to borrow money, especially at competitive interest rates, as it is considered to be riskier than other borrowers. This is true for all types of loans, including secured and unsecured types, although there are options available for the latter.
Key points to remember
- A person is considered to have bad credit if they have a history of not paying their bills on time or if they owe too much money.
- Bad credit often results in a low credit score, typically below 580 on a scale of 300 to 850.
- People with bad credit will have a harder time getting a loan or credit card.
Unexpected things that lower your credit score
Understanding bad credit
Most Americans who have ever borrowed money or purchased a credit card will have a credit history on one or more of the top three credit bureaus, Equifax, Experian and TransUnion.The information in these files, including how much money they owe and whether they pay their bills on time, are used to calculate their credit score, a number that aims to be a guide to their solvency. The most common credit score in the United States is the FICO score, named after the Fair Isaac Corporation, which designed it.
A FICO score is made up of five major elements:
- 35% – payment history. This is what carries the most weight. It simply indicates whether the person whose FICO score was paid to them paid their bills on time. Missing only a few days can count, although the more overdue the payment, the worse it is considered.
- 30% – total amount owed by one person. This includes mortgages, credit card balances, auto loans, collection bills, court judgments, and other debts. What is particularly important here is the person credit utilization ratio, which compares the amount of money they have available to borrow (like the total limit on their credit cards) with the amount they owe at any given time. Having a high credit utilization rate (for example, greater than 20% or 30%) can be seen as a danger signal and result in a lower credit score.
- 15% – length of a person’s credit history.
- 10% – mix of credit types. This can include mortgages, auto loans, and credit cards.
- 10% – new credit. This includes what someone has recently accepted or requested.
Examples of bad credit
FICO scores range from 300 to 850, and traditionally borrowers with scores of 579 or less are considered to have bad credit. According to Experian, about 62% of borrowers who score at or below 579 are likely to become seriously behind on their loans in the future.
Scores between 580 and 669 are considered fair. These borrowers are much less likely to become seriously delinquent on loans, which makes them much less risky to lend than those with bad credit. However, even borrowers in this range may face higher interest rates or have difficulty obtaining loans, compared to borrowers who are closer to this upper bar of 850.
How to improve bad credit
If you have bad credit (or fair credit), there are steps you can take to get your credit score above 669 and keep it. Here are some tips on how to do it, straight from FICO.
Set up automatic online payments
Do this for all of your credit cards and loans, or at least get on the email or text reminder lists provided by lenders. This will help you pay at least the minimum on time each month.
Beware of “quick fixes” advertised to your credit score. FICO warns that there is no such thing.
Pay off credit card debt
Make payments above the minimum due whenever possible. Set a realistic repayment goal and work on it gradually. Having high total credit card debt damages your credit score and paying more than the minimum owed can help raise it.
Check interest rate information
Credit card accounts provide this information. Focus on paying off debt at the highest interest rate as quickly as possible. This will free up the most cash, which you can then start to apply to other low-interest debt.
Keep unused credit card accounts open
Don’t close your unused credit card accounts. And don’t open new accounts you don’t need. Either move can damage your credit score.
If bad credit has kept you from getting a regular credit card, consider apply for a secure credit card. It is similar to a bank debit card, in that it allows you to spend only the amount you have on deposit. Have a secure card and making timely payments can help you rebuild a bad credit rating and eventually qualify for a regular card. It’s also a good way for young adults to start building a credit history.