What Is Bad Credit?
Bad credit refers to a person’s history of failing to pay bills on time, and the likelihood that they will fail to make timely payments in the future. It is often reflected in a low credit score. Companies can also have bad credit based on their payment history and current financial situation.
A person (or company) with bad credit will find it difficult to borrow money, especially at competitive interest rates, because they are considered riskier than other borrowers. This is true of all types of loans, including both secured and unsecured varieties, though there are options available for the latter.
- A person is considered to have bad credit if they have a history of not paying their bills on time or owe too much money.
- Bad credit is often reflected as a low credit score, typically under 580 on a scale of 300 to 850.
- People with bad credit will find it harder to get a loan or obtain a credit card.
Examples of Bad Credit
Your credit score is based on five different factors, each of them weighted differently. All of them can contribute to bad credit.
- Payment history (35%): If you have a history of delinquent debts or credit cards that you haven’t paid off, you are likely to have a lower credit score.
- Amounts owed (30%): A bad credit score is often due to owing large amounts of money. The more you already owe, the less likely you are to be able to pay off the new debt.
- Length of credit history (15%): If you have been reliably paying off debts for several years, you are a less risky borrower. A shorter credit history, however, will lead to a lower credit score. This is also influenced by how long individual credit accounts have been open and whether you have inactive accounts.
- Credit mix (10%): Having a variety of types of credit—such as a credit card, a retail card, a rental history, and a car loan—improves your credit score. Having only one type of credit account will lower it.
- New credit (10%): People who open multiple new credit accounts in a short period of time are statistically riskier borrowers and are more likely to have bad credit.2
- While your credit score gives you and lenders a quick indication of your credit standing, you don’t have to check your credit score to know whether you have bad credit. A few signs of damaged credit can include:
- Having your application for a loan, credit card, or apartment denied
- Unexpected credit limit cuts
- Interest rate increases
- Receiving communications from a debt collector
If you’ve been more than 30 days late on a credit card or loan payment, or you have multiple maxed-out credit cards, your credit score has likely taken a hit.
Ordering your credit score from myFICO.com is one of the best ways to confirm your current credit standing. There are also a number of free credit score services you can use to check at least one of your scores from the most widely used credit bureaus (Equifax, Experian, and TransUnion).
Free credit score services don’t always provide a FICO score, and usually only supply a limited view of your credit. For example, you may only get a credit score from Experian and not TransUnion or Equifax.
To understand what’s affecting your credit score, you’ll have to take a look at your credit report. This document contains all the information used to create your credit score.
Until April 2021, you can get a free weekly credit report from all three predominant credit bureaus through AnnualCreditReport.com.
How to Improve Bad Credit
To improve your scores, start by checking your credit scores online. When you get your scores, you will also get information about which factors are affecting your scores the most. These risk factors will help you understand the changes you can make to start improving your scores. You will need to allow some time for any changes you make to be reported by your creditors and subsequently reflected in your credit scores.
Of course, certain credit score factors are typically more important than others. Payment history and credit utilization ratios are among the most important in many critical credit scoring models, and together they can represent up to 70% of a credit score, which means they’re hugely influential.
Focusing on the following actions will help your credit scores improve over time. A credit score reflects credit payment patterns over time, with more emphasis on recent information.
1. Pay Your Bills on Time
When lenders review your credit report and request a credit score for you, they’re very interested in how reliably you pay your bills. That’s because past payment performance is usually considered a good predictor of future performance.
You can positively influence this credit scoring factor by paying all your bills on time as agreed every month. Paying late or settling an account for less than what you originally agreed to pay can negatively affect credit scores.
You’ll want to pay all bills on time not just credit card bills or any loans you may have, such as auto loans or student loans, but also your rent, utilities, phone bill, and so on. It’s also a good idea to use resources and tools available to you, such as automatic payments or calendar reminders, to help ensure you pay on time every month.
If you’re behind on any payments, bring them current as soon as possible. Although late or missed payments appear as negative information on your credit report for seven years, their impact on your credit score declines over time: Older late payments have less effect than more recent ones.
2. Get Credit for Making Utility and Cell Phone Payments on Time
If you’ve been making utility and cell phone payments on time, there is a way for you to improve your credit score by factoring in those payments through a new, free product called Experian Boost.
Through this new opt-in product, consumers can allow Experian to connect to their bank accounts to identify utility and telecom payment history. After a consumer verifies the data and confirms they want it added to their Experian credit file, an updated FICO® Score will be delivered in real-time.
Visit experian.com/boost now to register. By signing up for a free Experian membership, you will receive a free credit report and FICO® Score immediately.
3. Pay off Debt and Keep Balances Low on Credit Cards and Other Revolving Credit
The credit utilization ratio is another important number in credit score calculations. It is calculated by adding all your credit card balances at any given time and dividing that amount by your total credit limit. For example, if you typically charge about $2,000 each month and your total credit limit across all your cards is $10,000, your utilization ratio is 20%.
To figure out your average credit utilization ratio, look at all your credit card statements from the last 12 months. Add the statement balances for each month across all your cards and divide them by 12. That’s how much credit you use on average each month.
Lenders typically like to see low ratios of 30% or less, and people with the best credit scores often have very low credit utilization ratios. A low credit utilization ratio tells lenders you haven’t maxed out your credit cards and likely know how to manage credit well. You can positively influence your credit utilization ratio by:
- Paying off debt and keeping credit card balances low.
- Becoming an authorized user on another person’s account (as long as they use credit responsibly).
4. Apply for and Open New Credit Accounts Only as Needed
Don’t open accounts just to have a better credit mix it probably won’t improve your credit score.
Unnecessary credit can harm your credit score in multiple ways, from creating too many hard inquiries on your credit report to tempting you to overspend and accumulate debt.
5. Don’t Close Unused Credit Cards
Keeping unused credit cards open as long as they’re not costing you money in annual fees is a smart strategy, because closing an account may increase your credit utilization ratio. Owing the same amount but having fewer open accounts may lower your credit scores.
6. Don’t Apply for Too Much New Credit, Resulting in Multiple Inquiries
Opening a new credit card can increase your overall credit limit, but the act of applying for credit creates a hard inquiry on your credit report. Too many hard inquiries can negatively impact your credit score, though this effect will fade over time. Hard inquiries remain on your credit report for two years.
7. Dispute Any Inaccuracies on Your Credit Reports
You should check your credit reports at all three credit reporting bureaus (TransUnion, Equifax, and Experian, the publisher of this piece) for any inaccuracies. Incorrect information on your credit reports could drag your scores down.
Verify that the accounts listed on your reports are correct. If you see errors, dispute the information, and get it corrected right away. Monitoring your credit on a regular basis can help you spot inaccuracies before they can do damage.
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They will help recover your credit report and email it to you. Then they’ll go over the specific details of your credit history with you and identify what items in your history are damaging your credit. They will also analyze your positive credit and explain how to optimize your report using techniques for paying bills and opening or closing credit. You are billed nothing until this is complete and you’ve decided to move forward with our service. Truly no obligation. Whether or not you sign up, They bet you’ll learn something.
Help to Understand Your Credit
Credit damage is only half of what influences your credit report. You need to build a balanced report by continuously generating new months of positive history. They will show you how.
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The right ways to get a loan with bad credit
1- Check your credit reports and credit scores
“If you don’t know where your finances stand, it’s best to do some personal digging to figure out what’s in your accounts,” says Cody Green, co-founder of USA Drives.
One way to find out what you owe on your current credit cards is by checking your credit reports (if your credit card issuer reports to the consumer credit bureaus). Checking your credit reports is important because some of the information contained in them is used to calculate your credit scores.
You’ll want to make sure there are no incorrect derogatory marks on your reports before applying for a loan. The three major consumer credit bureaus Equifax, Experian, and TransUnion aren’t perfect, so it’s important to read your credit reports carefully. If there are false negative marks, you should contact the specific credit reporting company generating the report along with the information provided to get the error removed.
You can see what’s on your TransUnion® and Equifax® credit reports, as well as your credit scores from the two bureaus, by signing up for a free Credit Karma account.
Knowing your credit scores is important, too. Your credit scores, along with other factors, such as your debt-to-income ratio, can affect your approval odds for a loan and the terms you qualify for. Don’t be discouraged if your scores are not what you’d like. A little bit of work could help put your scores in better shape.
2. Improve your credit health
Once you have a better idea of your credit, it’s time to start improving your credit health. Your credit scores are calculated using different credit factors and scoring models. Try to focus on the factors with the most impact, like payment history, but do your best to improve your credit health overall. Factors that can impact your credit scores include …
- Payment history: While you can’t change the past, making all of your current payments for at least the minimum amount and on time is key for this portion of your scores.
- Credit usage: Do your best to keep the amount of debt you owe low compared to your total credit limit, ideally less than 30%. Maxed-out or over-the-limit lines of credit can be particularly harmful.
- Length of credit history: Keeping old accounts open instead of closing accounts after they are paid off can help increase your credit history length.
- Credit mix and types: While you shouldn’t apply for a new type of credit to influence this portion of your scores, it can naturally grow over time as you experience major financial events, such as buying a home.
- Recent credit: Opening or applying for several new credit accounts in a short period of time can make you seem risky to lenders. Opening new credit accounts only when necessary and when you know you can handle them responsibly is usually the best bet.
3. Shop around with multiple lenders to compare options
Once you’ve worked on improving your credit health as much as possible ahead of applying for a loan, it’s time to start shopping around for the best loan for you. While some people may simply choose the first loan they’re approved for, that could be a major mistake.
Different lenders may offer varying interest rates and loan terms depending on their assessment of your creditworthiness and risk. Lenders have their own methods for evaluating these factors.
“While there is a selection of lenders and loan facilitators who can help low-credit applicants obtain affordable and reputable financing, not all loan features are created equally,” says Green.
For example, one lender may offer you a loan with a 20.99% annual percentage rate while another can offer you a loan with a 16.99% APR. If you don’t shop around and accept the first offer of 20.99% APR, you would be overpaying by 4 percentage points.
Shopping around for loans is easier than ever today thanks to the internet. While you should still check into your local options, such as banks and credit unions in your area, you can easily view the estimated loan terms of various online lenders in one place using Credit Karma.
4. Know the different types of loans you can consider
The types of loans you want to consider will vary based on your goals, but there are two major classes of loan products.
Unsecured loans, such as personal loans, can be used to refinance high-interest-rate debt, finance an unforeseen expense, or cover most other expenses you may want to finance. However, unsecured bad-credit loans usually have higher interest rates than secured loans and can be more difficult to obtain.
Secured loans, such as a home equity line of credit, are secured by collateral and may provide you with an alternative to an unsecured loan at a lower interest rate. However, secured loans put your collateral at risk of being repossessed if you don’t repay the loan as agreed. These loans can be easier to get than unsecured loans.
Whether you decide to apply for a secured or unsecured loan, you may want to consider loans that allow a co-signer. If you’re able to find someone with healthy credit to co-sign a loan, you may be able to secure a lower interest rate than by simply applying for the loan in your name alone.
5. Understand the types of loans to avoid
If you’re in the market for a loan, you should evaluate your finances to see how much you can afford to borrow responsibly. But even if you desperately need access to money, there are some types of loans you should do your best to avoid. For instance, payday loans and auto title loans often have short terms, high-interest rates, and high fees that can harm your finances.
When evaluating a loan, try to avoid loans that have high origination fees, steep fees or interest rates, and extremely short loan terms. These types of loans may aim to take advantage of people who desperately need the money and have few other options.