What Is Bad Credit and How to Fix It

Woman looking at computer screen with credit card
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When you're talking about credit, or basically the level of trust potential lenders have that you'll repay money you've borrowed, you could fall anywhere on a scale from very bad credit, meaning no one will lend you any money, to having outstanding credit, where banks and credit companies practically beg you to borrow. Most people fall somewhere in between these two extremes.

How to Define "Bad" Credit

Bad credit generally describes a record of past failures to keep up with payments on your credit agreements, resulting in the inability to get approved for new credit. It typically means you haven’t paid your credit and other obligations on time, or haven't paid them at all. Your credit report also takes into account public records such as any state or federal tax liens, bankruptcies, or legal judgments against you.

Companies called credit bureaus (also referred to as credit reporting agencies) collect your credit history and compile it into a credit report. Each agency maintains its own separate report, and your credit history and scores could vary among them, due to errors or omitted information. Although you'll see the records and history for all of your actual credit accounts on your credit report, you won't find any credit score on your credit report.

FICO Scores

Each credit bureau calculates a FICO score based on your credit information. The Fair Isaac Corporation (FICO) developed the software and algorithms to calculate this score; hence, the name. Different companies such as auto lenders, mortgage lenders and credit card companies look at potential borrowers differently according to their needs, so to accommodate this, dozens of FICO score variations and calculations exist. Credit scores range from 300 to 850, with 650-670 being considered the low end of a "good" credit score and lower scores indicating increasingly lousy credit.

 

Having a lot of negative records, late payments or possibly a loan default on your credit report can undoubtedly result in lower credit scores. If you've had accounts sent to a collection agency, such as unpaid medical bills, the collection agency could report your delinquency to the credit bureaus even if the hospital does not.

Bad credit often results when people go through a rough spot financially, triggering multiple negative events in a short period of time such as charging up high balances recently on credit cards, filing bankruptcy or having a vehicle repossessed. Some negative events need only happen once, such as a tax lien or real estate foreclosure, to make lenders wary of working with you. 

The Fallout from Poor Credit

Once you have poor credit, lenders are less likely to lend to you because of the increased probability that you could fall behind on any new credit card or loan accounts. You might find all your applications for credit denied, or if you do get approved, you’ll likely receive a much higher interest rate than borrowers who have good credit scores. The increased interest rate is a lender's way of compensating themselves for the risk of loaning money to you.

Bad credit affects more than just your credit card and loan approval and interest rate. Some insurance companies consider your credit score when quoting you an insurance rate. Utility and cell phone providers often charge a security deposit for applicants with poor credit. Landlords may require a higher security deposit if you have bad credit, or they may turn you down for a lease or rental agreement altogether.

Check Your Status and FICO Scores

If you typically stay on top of your finances, you may have a decent idea of where your credit score falls. You know if you've been late on any loan payments lately, or have large credit card balances that exceed 30 percent of your available credit. If you've recently had credit applications turned down, your credit card interest rates have increased or your card issuers have lowered your credit limits, take these things as a sign that your credit score's on its way down.

Find out your FICO credit score and get a copy of the actual information reported on your credit record. You might find out that one of the credit bureaus hasn't recorded an account that has a positive payment history, or you could even find mistakes that have lowered your credit score needlessly. You can get one free copy of your credit report each year from each of the three credit bureaus, TransUnion, Equifax, and Experian.

Checking your credit report will help you figure out what's hurting your credit score. The Federal Trade Commission (FTC) has authorized only one website, AnnualCreditReport.com, to provide these reports. You can also get free estimates of your FICO score by signing up for one of the many credit monitoring websites. Many of them offer a basic account with FICO scores from one or two of the three credit bureaus for no charge. You don’t need to spend money to find out what’s causing your bad credit.

Many of these sites also have credit score simulators, which show you how much your credit score could move up or down by paying down accounts, opening new accounts and other changes.

Take Steps to Repair Your Bad Credit

Bad credit doesn’t have to last forever. You can take steps to improve your credit score over time. First, focus on removing negative information from your credit report either by using a  credit report dispute or a credible credit repair technique. Also, the impact of some negative marks on your credit report lessen over time, so sometimes all you have to do is wait things out. Focus on adding positive information to your credit report by adding new accounts and consistently paying them on time.