Bad Credit: The Problem & Solutions

A good measure of your financial status is your credit rating. This is reflected by your credit score and other components of your credit profile. A bad credit score can result from not paying your debts on time every month or from having too many debts with high balances close to or at their limits. If you have bad credit, lenders treat you as a credit risk. They believe you are less likely to make timely payments or repay your debts in full. A bad credit score can substantially affect your financial status. It can make it more difficult for you to get a mortgage, auto loan, or other loans to refinance existing loans. It may also make it difficult to get a credit card or open a checking account.

It is possible to increase your credit score if you are proactive. This article will look at what’s considered a poor credit score, the consequences of having bad credit, and strategies to improve your credit.

What’s a Bad Credit Score?

Many factors determine your credit score. Each of them affects your credit score by a set percentage. These factors include: 

• Payment history 

• Amounts owed

• Length of credit history

• New credit

• Credit mix (types of credit) 

There are two common credit scoring models: FICO and VantageScore. FICO defines any score in the range of 300 to 579 as a poor credit score. Scores between 580 and 669 are considered fair. So lenders may consider scores under 670 as inadequate or bad credit scores. VantageScore considers credit scores between 300 and 600 as very poor or poor. A score between 601 and 660 is a fair credit score. So under this model, scores under 660 could be considered bad or inadequate.

Credit Report

A credit report is an extensive list of your credit accounts, payment history, and other events that affect your overall credit. It includes the names of lenders that have provided loans and credit, as well as the credit limits of your accounts. A credit report is a transcript of your financial history. Federal law allows you to get a free credit report every 12 months from each credit reporting company. The law gives you the right to ensure that the information contained in all of your credit reports is current and correct. Some reporting agencies and other websites may also provide a free credit score.

Two models of credit scoring are used in the United States. These models are VantageScore and the more commonly known FICO. Founded in 1956, FICO is a data analytics company that provides credit scoring services. Created as a joint venture by the three major credit bureaus—TransUnion, Experian, and Equifax—VantageScore is not a company but a consumer credit-scoring model used by the three credit reporting bureaus.

The VantageScore and FICO scoring models determine your credit scores using the information contained in your credit reports. This data is collected by the credit bureaus. A bad credit score indicates that a borrower’s credit report and credit history contain negative items. To lenders, this is an indication that it might be risky to extend credit to this borrower.

A Bad FICO Score

The base FICO scores range from 300 to 850. These scores are broken down as follows:

• A poor credit score is 300–579.

• A fair credit score is 580–669. 

• A good credit score is 670–739. 

• A very good credit score is 740–799.

• An excellent credit score is 800 or up.

On the FICO Score scale of 300 to 850, a bad credit score is one below 670. 

FICO Score Factors

FICO uses percentages to represent the importance of each item that affects your score. But the final calculation of your credit score will depend on your unique credit history on your credit report. FICO considers scoring factors in the following order:

• Payment history: 35%

• Amounts owed: 30%

• Length of credit history: 15%

• Credit mix: 10%

• New credit: 10%

Your payment history is the most important factor impacting your credit score. Missing even one payment can harm your credit score. 

The total amount of debt owed is part of the formula to calculate your credit utilization ratio. This is the next most important factor in calculating your score. The credit utilization ratio is calculated by dividing your total use of credit by the total of all your credit limits. If your total revolving limits add up to $10,000 and the total amount of debt that you owe is $2,500, your credit utilization ratio is 25%. Lenders prefer a credit utilization ratio of 30% or less. 

The length of time that you’ve held credit accounts is the next most important factor. This measures the age of your newest account, the age of your oldest account, and the average age of all your accounts. The longer your credit history, the better your credit score. 

Credit mix is a factor that considers the diversity of your credit accounts. There are many types of credit from mortgages to credit cards. Your credit mix shows your capacity to manage different types of credit. 

New credit examines how many new credit accounts you've opened and how many hard inquiries were made by lenders when you submitted a new application for credit. Too many accounts or inquiries is a red flag to lenders since it shows that you could be an undesirable credit risk. Too many inquiries will lower your credit score.

A Bad VantageScore

While FICO only splits lower scores into fair and poor categories, VantageScore splits lower scores into fair, poor, and very poor categories

The base VantageScores range from 300 and up. The credit score range is as follows:

• A very poor credit score is 300–499.

• A poor credit score is 500–600.

• A fair credit score is 601–660. 

• A good credit score is 661–780. 

• An excellent credit score is 781 or up.

According to the VantageScore rating model, a bad score would be below 600. If you consider a poor score as any score that isn’t good, a bad credit score under this system would be anything below 661.

VantageScore Factors

VantageScore considers five factors by their degree of influence to determine your credit score. VantageScore considers factors in the following order:

• Total credit usage, balance, and available credit: Extremely influential

• Credit mix and experience: Highly influential

• Payment history: Moderately influential

• Age of credit history: Less influential

• New accounts opened: Less influential

Total credit usage, balance, and available credit are extremely influential and take into consideration your credit utilization. As mentioned above, lenders are looking for credit utilization ratios of 30% or lower. 

Credit mix and experience review the kinds of credit that you have. A mix of revolving credit, like credit cards, and installment credit, like a mortgage or a car loan, is considered the best credit mix. This is a highly influential factor.

Payment history reviews your record of paying your bills on time. New accounts looks at your requests for new credit. The age of credit history is the length of time that you have maintained your credit accounts. 

Warning Signs of Damaged Credit

Your credit score gives an accurate snapshot of the present state of your credit. A score in the fair or poor range is a clear indication that you do not have good credit. Other red flags that will tell you if your credit is poor or fair include the following:

• You’re contacted by a debt collector

• You start receiving subprime credit offers

• A loan application is denied

• A utility company requires you to make a security deposit on your account

• Your credit card issuer closes your account

• Your credit card issuer won’t lower the interest rate of your credit card

• Your credit card issuer denies your request to raise the credit limit of your credit card

If you make a loan or credit card payment more than 30 days late, you should expect your credit score to decrease. Also, if you’ve reached the credit limit on an account, you should expect your credit score to drop.

Bad Credit Consequences 

There are many consequences to having bad credit. If you are regularly making payments that are not on time, you will be charged late fees. If you have a high interest rate, your balance will accumulate quickly. Also, it can be more difficult for you to get credit or a loan in the future. If you do receive a credit offer, it’s likely to contain unfavorable terms like a lower credit limit with a higher interest rate and monthly payment. 

Bad credit can affect other aspects of your life as well. It can make it more difficult or costly to get housing, insurance, a cell phone, and even a job. 

Strategies for Improving Your Credit Score

If you’re having difficulty finding credit or a loan because you have bad credit, it is possible to improve your credit score. It won’t happen overnight. Improving your credit can take months or years, but it is possible. As you work to improve your score, remember that negative entries like foreclosure (or a short sale) and bankruptcy will eventually age off and don't affect your credit forever.

If you want to address your credit problems and increase your credit score, you can also seek professional advice. There are many consumer credit counseling agencies that offer services for little or no cost. 

Here are some ways you can improve your credit score.

Make On-Time Payments

Making one late payment may seem harmless but even one late payment can have a negative effect on your credit. Make sure that you make each payment by the due date, and whenever possible, pay more than the minimum amount due.

Avoid Applying for New Credit When Possible

Applying for new credit has consequences. Every time you apply for new credit like a credit card, the lender or card issuer makes a hard inquiry. These types of inquires negatively affect your credit score. Soft inquiries, which occur when you check your credit score and credit report, do not harm your credit. 

Avoid High Credit Card Balances 

Every time that you use any of your available credit without a corresponding increase in your credit limit, you increase your credit utilization ratio. Having even one high credit card balance can significantly affect your overall ratio. If your balance for an account is $2,400 and your credit limit is $3,000, your credit utilization ratio for this account is 80%. 

To maintain an overall utilization rate of 30%, you would need to have $5,000 of available credit in all your other accounts ($2,400/$8,000 = .30). But any use of this other credit would increase your ratio to more than 30%. Lenders prefer potential borrowers to have credit utilization ratios of 30% or lower.   

Check Your Credit Report

Federal law, through the Fair Credit Reporting Act (FCRA), entitles every consumer to a free credit report each year from each of the three major consumer credit bureaus. 

The FCRA requires that the credit bureaus:

• Provide a free copy of your credit report once every 12 months;

• Ensure that any personal information they collect is accurate; and

• Allow you the opportunity to repair any errors.

Keep Old Accounts Open

Since the length of your credit history affects your credit score, keeping an old credit card account open can increase the age of your overall credit history and help maintain a good mix of credit types. Just because you keep this account doesn’t mean you have to use it. But if you do, it will affect your credit utilization.

Let's Summarize...

A bad credit score can affect your ability to get a mortgage loan, a car loan, a credit card, or other forms of credit. At the least, it’s important to keep your credit score out of the fair and poor ranges. This means you need to have a minimum FICO score of 670 and a minimum VantageScore of 661.

Many factors go into calculating a credit score. From most important to least, FICO considers payment history, amounts owed, length of credit history, credit mix, and new credit. VantageScore considers similar factors and ranks them from extremely to less influential. It’s important to know when your credit score has dropped so you can be proactive and take steps to increase your score. Making payments on time, keeping credit utilization low, checking your credit report regularly for accuracy, and even keeping an old account open can help keep your credit score in the good or better range.