Having bad credit can feel frustrating and make financing major life expenses more difficult. But with an understanding of what causes bad credit, and a strategic approach, there are ways to rehabilitate and rebuild credit over time.
This comprehensive guide examines what constitutes bad credit, reasons it occurs, and actionable tips people can take to work towards improving their credit and financial standing. With effort and diligent financial management, credit scores can be boosted from “bad” and “fair” ranges to “good” or higher over time.
What is a Bad Credit Score?
In the United States, the most commonly used credit scoring model is the FICO Score, developed by the Fair Isaac Corporation, which ranges between 300 and 850. Generally, a FICO Score below 620 is considered a poor or bad credit score. Those with scores between 580-619 are viewed as having fair credit, which is still below average.
On the positive side, a FICO Score between 680-719 is regarded as good credit, while 720 and above is seen as excellent. So where does your credit score fall on this spectrum? And what does having a low score really signify to lenders and creditors?
Simply put, the lower the credit score, the higher the perceived risk that person may not repay their debts. Creditors and lenders rely heavily on credit scores when deciding to extend financing at certain rates. The higher the credit score, the more likely the applicant is to be approved for loans and accounts with better terms like lower interest rates.
Those with poor credit are viewed as riskier borrowers by lenders. They will often be declined or only approved for the bare minimum credit limits and highest interest rates. Some may be asked to provide collateral or larger down payments to offset the risk of nonpayment.
So if your goal is to obtain financing approval at the best rates for credit cards, auto loans, mortgages and other needs, improving a bad credit score should be a priority.
How Credit Scores Are Calculated
The FICO credit score model takes into account five core factors to calculate a score ranging from 300 to 850. Understanding what goes into this calculation helps pinpoint areas to focus on improving:
1. Payment History (35% of Score)
Whether bills like mortgages, credit cards, utilities, or other loans are paid on time makes up over one third of a credit score. Payment history looks at the track record over the past several years and late or missed payments can hurt scores significantly. The more severe the lateness or delinquencies, the more it damages the credit score.
Paying all bills by their due dates demonstrates consistent and responsible financial management to creditors. Even one or two missed payments can shave points off and move someone from a prime to subprime credit score.
2. Credit Utilization (30% of Score)
This factor looks at how much of the total available credit is being used across all revolving accounts like credit cards. Maintaining a low balance relative to the credit limit signals better financial discipline to lenders.
It’s recommended to keep credit utilization below 30%. That means on a credit card with a $5,000 limit, the balance should ideally stay under $1,500. Maxing out cards or carrying large balances month to month hurts this aspect of the score significantly.
3. Credit History Length (15% of Score)
The age of the credit history across all accounts is also a factor. In general, the longer the credit usage history while managing accounts responsibly, the better. Having established accounts for over 10 years has the most positive impact.
For those new to credit or who do not have long-standing accounts, this category is not as developed which can dampen the overall score. Building up a consistent history of on-time payments and prudent usage over time helps in this category.
4. Credit Mix (10% of Score)
Creditors like to see experience managing different types of credit accounts including installment loans (mortgages, student loans, auto loans) and revolving accounts (credit cards). Having a mix of account types demonstrates proficiency handling various credit obligations.
For those starting out, having at least one of each major account type can benefit the credit mix portion of the overall score. As the mix diversifies over time through responsible usage and payments, this aspect of the score improves.
5. New Credit Applications (10% of Score)
When applying for new credit accounts, lenders will conduct a hard inquiry on the borrower’s credit reports. Too many new applications in a short span of time presents greater risk in lenders’ eyes and can lower scores moderately.
Limit new account applications to only when truly needed. Also, shop for major loans like mortgages and auto loans within a short window so multiple inquiries only count as one inquiry. With careful management of applications, this factor should remain in good standing.
Now that you understand the key ingredients of credit scores and where they most commonly suffer, we can discuss the leading causes of bad credit situations.
Common Reasons for Bad Credit
There are a few typical credit missteps and high-risk behaviors that can tank otherwise good scores. Being aware of these common pitfalls helps avoid or rectify them quickly:
Missed or Late Payments
As payment history is 35% of the credit score equation, late payments on bills or debt obligations like credit cards and loans take the biggest toll. Even one 30-day late mark can quickly shave off points and move someone from fair to bad credit.
Set up autopay or calendar reminders for all bills to avoid overlooked due dates that lead to delinquencies. If a financial hardship occurs, immediately call creditors and negotiate alternative payment arrangements. They may be willing to waive late fees or make other accommodations.
Maxed Out Credit Utilization
Carrying high balances relative to available credit limits exceeds the 30% utilization threshold and drags down credit scores. This signals high risk to lenders concerned about recouping debts owed.
Create a budget to live below your means and pay down balances consistently each month. As balances decrease and stay low, this factor will improve. Also request periodic credit limit increases from issuers to keep the utilization percentage lower.
Short or Null Credit History
Those new to credit or who lightly use accounts may not have enough positive history established to generate a robust credit score. Typically, bad credit results from misusing credit. No credit history at all produces a thin file with insufficient data.
Open one or two starter accounts like a secured card or credit-builder loan to create positive records. Use accounts responsibly with on-time payments and low balances. Let your good history accumulate year after year.
Too Many Credit Applications
Applying for financing, whether approved or denied, causes multiple hard inquiries on credit reports. While shopping for the best rate on a single loan is fine, too many inquiries from serial applications worry creditors.
Only apply for accounts truly needed and space out applications by 6-12 months. Limit accounts to what you can responsibly manage at your income level. Avoid offers for financing you could live without.
Major Derogatory Events
Any accounts that go to collections, bankruptcies, foreclosures, tax liens, judgments, or other delinquencies severely wreck credit scores for many years. These demonstrate extreme financial risk and irresponsibility to lenders.
Do everything possible to avoid these scenarios, even if it means major lifestyle cutbacks during financial challenges. Seek credit counseling and negotiate with all creditors first. The damage caused lasts 7-10 years.
While anyone can stumble financially at some point for a variety of reasons, multiple issues across these categories during a short period signifies high-risk behavior that demolishes a credit score. The path to rebuilding lies in demonstrating changed habits over time.
Practical Tips to Rebuild and Improve Bad Credit
Repairing bad credit requires diligence and financial discipline, but within 6-12 months of vigilant effort, it is possible to boost scores from “bad” or “fair” into the “good” credit range. Eventually with ongoing responsible habits, “excellent” credit scores can become attainable.
Here are proactive tips that can turn around your credit situation:
Review Credit Reports for Any Errors
One important first step is to check all 3 major credit bureau reports closely. Ensure all information listed is valid. Dispute and correct any inaccurate entries like closed accounts listed open or late payments marked when they were on time. Fixing errors can provide an immediate boost.
Also have any outdated negative items removed by disputing them if they are past the 7-10 year reporting limits. This removes their score-lowering influence.
Make All Payments On Time
Set up autopay through creditor websites and monitor accounts routinely. Being even just 30 days late can severely hurt. Calendar billing due dates and set payment reminders.
If faced with financial hardship that may prevent paying on time, call creditors preemptively to negotiate alternative arrangements. They can often waive late fees and set up reasonable payment plans. This demonstrates responsible conduct.
Pay Down Balances
Ideally, pay off balances in full each month if possible, but also allocate consistent monthly amounts to pay down balances gradually. Even $20-50 a month per account helps reduce debt load over time.
Aim to get credit utilization below 30% across all accounts. As balances decrease### Pay Down Balances
Ideally, pay off balances in full each month if possible, but also allocate consistent monthly amounts to pay down balances gradually. Even $20-50 a month per account helps reduce debt load over time.
Aim to get credit utilization below 30% across all accounts. As balances decrease, this factor will start to improve month by month as long as limits are managed prudently. Avoid accumulating new balances after paying down existing debt.
Keep All Accounts Open
Unless an annual fee makes keeping it unwise, do not close unused credit cards. Keep accounts open and active even with a small occasional purchase that is paid off. This preserves the length your credit history has accumulated.
Long-standing accounts support a healthy average age of credit lines which helps the credit mix factor. Just be sure unused cards don’t present temptation to overspend.
Request Credit Limit Increases
After 6-12 months of consistently on-time payments and lowered utilization, creditors may grant credit line increases without requiring new hard inquiries. This further supports lowering your overall credit utilization.
Take care not to spend up to new higher limits though. Be judicious with limit increase requests and space them out on different accounts periodically.
Open New Credit Accounts Only When Needed
Too many new accounts may signify risk, so only apply for new credit when you truly require it and have the financial means to manage it responsibly. Space out new accounts by 6-12 months.
If needed, secured credit cards and credit-builder loans can help establish positive history for those new to credit or rebuilding. Use them prudently over time and graduate to unsecured credit when scores improve.
Give It Time
Improving credit takes diligence and patience over months and years. But with responsible financial habits, credit scores can move from “bad” to “good” or higher gradually. Monitor your reports frequently and continue strengthening your credit health over the long term.
Key Takeaways
- A FICO credit score below 620 is considered bad or poor credit, making financing approval difficult. Scores of 580-619 are still below average.
- Payment history, credit utilization, credit history length, credit mix, and new inquiries comprise your credit score. Address weak spots in these areas.
- Missed payments and high balances relative to limits cause the most damage. Stay current on bills and pay down debts.
- Even serious errors can be overcome with diligent effort and prudent financial moves over 6-12 months in most cases.
- Responsible credit stewardship over time leads to improved credit access and better interest rates. Be patient and persistent.
Frequently Asked Questions
How long does it take to improve a bad credit score?
With diligent effort, credit scores can often be raised from “bad” to “fair” or “good” ranges within 6 to 12 months. Excellent scores may take 1-2 years to achieve through ongoing responsible financial moves.
What is the fastest way to improve a bad credit score?
Correcting reporting errors and paying down balances to lower credit utilization can provide the quickest score improvements in 30-60 days when combined with on-time payments.
How many points can you raise your credit score in a month?
Implementing responsible credit habits, you can expect to raise your credit score anywhere from 50-100 points or more within one month’s time in some cases. But ongoing diligence is key.
Is a credit score of 550 bad?
Yes, a credit score of 550 is considered deep subprime and signals significant risk to lenders. Scores below 620 are viewed as bad or poor. 550 is on the lower end of that poor range.
Can I buy a house with bad credit?
Not immediately in most cases, but after diligently rebuilding credit into the fair or good ranges, and saving up a larger down payment, mortgage approval becomes possible over time even following past credit struggles.