What Is A Bad Credit Score And How Do You Improve It

What Is A Bad Credit Score And How Do You Improve It?

When we talk about credit, we have two extremes.

Very bad credit that makes you unattractive to traditional lenders and excellent credit, meaning companies and lenders compete to extend credit to you. Most people, however, fall in between these two extremes.

Credit, therefore, is an essential element of your finances, and you cannot afford to ignore it. It is what will determine if you qualify for a loan or not, and at what interest rates. Some employers and landlords may reject your application for a job or to rent their apartments simply because of bad credit.

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In this guide, you will find out what is a bad credit score, some of the consequences of bad credit, and measures to take to improve your scores.

 

So, what is a bad credit score?

When making a lending decision, lenders and credit companies will always check your credit scores to know whether you are a high-risk borrower or a good investment.

Below is a breakdown of FICO credit ratings:

  •    720+ – excellent credit.
  •    680 – 719 – good credit.
  •    629 – 679 – fair credit.
  •    580 – 619 – poor credit.
  •    579 and below – bad credit.

How does FICO arrive at your credit scores?

FICO uses the following algorithms to calculate your credit ratings:

  • Payment history – it’s important to note that timely payments raise your credit exponentially. Your payment history, therefore, includes things like account status, late payments, on-time payments, and any collection accounts on your credit report. It constitutes 35% of the total score.
  • Credit mix – having a combination of several credit accounts is a great plus to your credit scores. It’s not enough to have credit card accounts only. Instead, include a student loan, personal loan, mortgage, or an auto loan. This will positively impact your credit by 10%.
  • Credit utilization ratio – always strive to keep your rate at or below 30%. Credit utilization shows the amount of credit you use to what is available to you. When your credit utilization ratio is high, it’ll drop your ratings and imply that you mainly depend on loans to survive.
  • New accounts – it constitutes 10% and includes all the recently opened accounts and the number of inquiries made. Anytime lenders make an inquiry on your credit, your scores drop. If they are several inquiries, your ratings fall even further.
  • Credit usage history – several new credit accounts indicates a shorter credit usage history. It helps to hold on to your revolving credit card accounts and lines of credit because they have a positive impact on your credit ratings. Credit usage history constitutes 15% of your scores.

Contributing factors to bad credit score

Bad credit can be as a result of the following factors:

Skipped payments of bills and huge credit balances

Anytime you pay your bills late or inconsistently; you hurt your credit scores.

Usually, lenders will report late payments to credit bureaus, and that will have a negative impact on your ratings. Huge credit balances is also a contributing factor to poor credit.

Delinquency

Before lenders report your failure to pay your loans and credit card balances, they’ll try to get you to clear your debts through a third party company.

The collection agency will hound you with calls, emails, and messages. Some will even threaten you with legal action for you to pay your outstanding debts.

Even a collection account and a legal proceeding on your report affect your ratings.

If you, however, are still unable to pay up, the lender will report your account as delinquent to the three major credit bureaus, and your ratings will inevitably drop.

Bankruptcy and foreclosure

If you recently applied for bankruptcy or had your asset sold by the lender to repay your debts, you can be sure that it’ll appear on your reports for seven years.

Bankruptcy and foreclosure on your reports will impact your credit negatively.

The good news is that such information falls off your reports after seven years.

What are the consequences of bad credit scores?

Below are some of the negative effects of bad credit scores:

High interest rates

If you get a lender who’s willing to overlook your bad credit and approve your loan or credit card request, it will be at a very high interest rate.

Usually, lenders charge these high rates to cover the lending risk.

Such lenders will increase your interest rates without any prior warning. To them, you are a high-risk borrower, and there is no guarantee that you’ll pay your debts.

Your credit cards get closed without warning

It’s okay to have one credit card closed, but if all your card issuers are closing their accounts, chances are that there’s something wrong with your credit reports. You can call your card issuer to know what’s wrong. Repairing your credit may help you get a true and accurate credit standing.

Landlords keep turning you down

While some lenders may be lenient and may not overemphasize on your credit, some will be hesitant in renting their apartments to you if you have negative items on your credit file. One late payment could be excused, but if you are always late in paying your bills, it’s an indication that you are highly delinquent.

With such bad reports, you’ll need to fix your credit.

Your credit card application keeps getting rejected

Before accepting your request for a credit card, most lenders perform credit checks. If there is negative information on your credit reports like issues with delayed payment of bills, a collection account, or a defaulted loan, chances are your application will be rejected.

Several rejections indicate that you are a subprime borrower and lenders regard you as high risk, therefore, getting a loan or credit card, will be an uphill task for you.

You get rejected for employment opportunities

Getting a job can be a real hassle. Having bad credit makes the search more challenging.

With bad credit, getting a good job, especially in the financial sector can be very difficult.

Some lenders will check your credit reports before approving your job application, and any negative information on your reports will undoubtedly lower your chances of landing your dream job.

How to fix your bad credit scores

Fixing errors on your reports and improving your scores by even 100 points takes patience, hard work, and sacrifice.

The process is akin to a weight loss journey. It may be tough, but in the end, you’ll be happy that you didn’t give up.

Below is step by step procedure of raising your credit scores faster

Know your credit scores

The first and most crucial step in fixing your credit is getting a free credit report from the government website www.annualreports.com. From the report, you’ll know your credit scores.

Carefully analyze the report, and if there is any false negative information on your report that does not give you an accurate credit rating, you have the right to dispute them.

Raise a dispute to the credit bureaus

If you find errors on your report, raise a dispute to the credit bureaus, and make sure you present documents that’ll act as proof of your allegations.

The credit bureaus will contact your creditors to ascertain if your claims are true.

They’ll then contact you after 30 days with a new credit rating, or reject your applications if the negative information on your report is valid.

Pay bills on time

To raise your credit scores, you’ll have to pay your bills on time.

If you lack the discipline, you can have the bills and debts directly debited from your account every month.

You can also make a budget and stick to it. Avoid impulse buying to free up some cash towards your debt obligations.

Keep your credit balances low

Most credit companies charge high interest rates on credit balances.

Not paying your credit card bills on time means the balances plus interests may quickly add up and get out of hand. This will negatively affect your credit scores.

To avoid such occurrences, pay your credit card balances on time every month, and if the accrued balances get out of hand, you could consolidate them by taking out a personal loan, and paying them off at once, then focusing on a single loan at reduced interest rates.

Keep your credit utilization rate low

Your focus should be to keep your credit utilization rate at or below 30%.

Credit utilization rate indicates the amount of credit you use or are currently using.

To lenders, a higher rate shows that you are highly dependent on loans, and therefore, are a high risk.

Avoid taking out several loans at a time and keep to credit limits that you can comfortably repay.

Keep a keen eye on your spending habits

All the above hard work will go to waste if you don’t change your money management habits.

Live within your means and take out loans that you only need and are sure you can repay.

Avoid impulse buying and instead of over-relying on loans. Have some funds set aside for an emergency.

Bottom line

You cannot afford to ignore your credit. It’ll affect every aspect of your life.

The information above is all that you need to identify areas of your life that are affecting your credit scores and how to change them.

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