Having a bad credit score can be a hindrance: It makes it more difficult to make major purchases, obtain a loan, and get a credit card. But it can also affect other areas of life that have little to do with finances.
So we know that your credit score is important, but what exactly qualifies as a bad credit score? Find out more about what a bad credit score is, what behaviors lead to a poor score, and how you can improve it.
What Is Considered a Bad Credit Score?
Credit scores are defined on a numerical scale -- usually between 300 and 850. But what exactly do these numbers mean? What qualifies as a good credit score and a bad credit score? The short answer: It varies.
Each lender sets its own standards and definitions for good and bad credit scores. This means that most people actually have multiple credit scores. However, the two most commonly used scales from FICO(FICO) - Get Report and VantageScore can be used as models for defining "good" and "bad" in a broad sense.
Here's a general guideline for the quality of your credit score:
- 720 and above: Excellent
- 690-718: Good
- 630-689: Fair
- 300-629: Bad
In short, any number under 630 is generally considered a bad credit score.
What to Expect With a Bad Credit Score
There's a reason why people work on maintaining good credit. Having a bad credit score can impact your life in a number of ways, both in the financial realm and beyond. Here's what you can expect if you have a bad credit score.
Rejected Credit Card and Loan Applications
Ultimately, a credit score measures how likely you are to pay back your debts completely and on time. A high credit score shows lenders that you are reliable. When you have a low credit score, you are considered a higher risk borrower. If your credit history is suboptimal, lenders may reject your applications altogether.
Higher Interest Rates
Even if your applications for credit cards and loans are accepted, people with a bad credit score will likely end up paying more than someone with a good credit score. Having a good credit score gives you the leverage to broker better deals with lenders and credit card companies. It shows that you are reliable. People with bad credit scores are riskier for banks, meaning that they will give you a higher interest rate to compensate for the risk. This means you pay more in the long run.
Trouble Buying a Car
Most people take a loan to buy a car. Before a bank provides you with an auto loan, it will check your credit score to determine if it should give you a loan and at what interest rate. If you have bad credit, your auto loan may be denied or come at a higher interest rate. While you may be able to purchase a car from a place that does not check your credit score, your interest rate will be significantly higher.
Difficulty Finding Housing
Most landlords will do a credit check before approving someone for an apartment or rental home. Bad credit can be an indicator that you won't pay your rent on time, so many landlords will reject applicants with a poor credit history. This is especially true in competitive markets. While some landlords will accept applicants with a bad credit score, they will usually charge a higher security deposit to make up for the risk.
Higher Insurance Premiums
Insurance companies argue that there is a link between poor credit scores and filing a higher number of claims. If an insurance company discovers that you have a bad credit score, it will likely charge you a higher premium -- even if you have filed very few claims in the past.
Difficulty Getting Cell Phone Service
No, a bad credit score doesn't lead to poor reception. But it does make it harder to land a contract with cell phone companies. Since they provide service on a monthly basis, they rely on timely payments to continue operating. If they do a credit check and discover you have bad credit, they will assume that you're less likely to pay on time or at all. People with bad credit instead may turn to prepaid cell phones.
Difficulty Starting a Business
It's extremely common to take out a loan before launching a new business, but getting a loan to can be incredibly difficult if you have poor credit. A bad credit score may limit the amount you can borrow or will cause banks to reject you outright. This is the case even if you come to the table with a well-thought out business plan and supporting documentation.
Difficulty Getting Hired
Some employers look into their job applicant's credit scores as part of the screening or interview process. It isn't unheard of for potential employers to reject applicants with bad credit scores. Why do employers care about credit score? Investigating the financial histories of potential hires helps employers gauge how the applicant handles finances, how organized they are, and if they are at a higher risk of committing financially motivated crimes like fraud and theft. While not all companies do this, many do, particularly in the financial industry.
Behaviors That Hurt Your Credit Score
A bad credit score can touch every part of your life, but what behaviors lead to getting poor credit in the first place? Avoid these practices if you want to keep your credit score from getting worse.
Making Late Payments
A good portion of your credit score is determined by payment history. If you consistently make late payments for credit cards or loans, this will negatively impact your credit score.
Not Making Payments
While making payments late is not good, not making payments at all is extremely bad for your credit score. This can also lead to a lender charging off.
Being in Collections
Most of the time, before a lender charges you off, they will hire a third party collector to help them obtain the money you owe. Collections agencies can be aggressive and may have unusual tactics, and being in collections is not just bad for your credit score, but can also cause a substantial amount of stress and embarrassment.
When a lender charges you off, it is assuming that you are incapable of paying your bill altogether. This is extremely damaging to your credit score, as it indicates to lenders that you are a high-risk borrower that may not just avoid payments, but will walk away from them completely.
Defaulting on a Loan
Similar to charging off, defaulting on a loan indicates that you will not fulfill your portion of the loan contract and pay back the money owed to the lender. This has an identical impact on your credit score to charging off.
Receiving a Judgment
Judgment means that you avoided paying your bills to the point where the court system needed to step in and force you to pay. Much like defaulting on a loan or charging off, judgments show that you are a high-risk borrower that lenders should be wary of. Unpaid judgments are especially damaging -- so if you find yourself receiving a judgment, it's important to pay it off as soon as possible.
Maxing Out Credit Cards
Another big factor influencing your credit score is your credit utilization and debt ratio. If you have a large credit card balance relative to your credit limit, you are considered a high utilizer. This lowers your score. If you max out a credit card and have a utilization rate of 100%, this can be extremely damaging to your score.
Closing Credit Cards
The length of your credit history is also taken into consideration when calculating your credit score. The longer your credit history, the better opportunity lenders have to determine your trustworthiness as a borrower. Closing credit cards erases them from your credit history, making it look shorter. If there is no annual fee or other expense, keep cards that you no longer use. Also, be wary of closing credit cards that have a balance remaining on them. If you close a credit card without paying off your balance, it will look like you maxed out your credit.
Having Limited Sources of Credit
Having a healthy mix of different credit sources contributes to calculating your credit score. If you only have a credit history that consists of one credit card or one loan, then this could potentially hurt your score. This is a common problem for younger borrowers, particularly those with a limited credit history.
Applying for too Many Things
When you apply for a credit card or a loan, the lender will perform a credit inquiry to evaluate whether it should give you a loan at all and what your interest rate should be. Credit inquiries are taken into account when calculating your credit score. If you apply for several credit cards and loans close together, then you might harm your score.
Much like defaulting on a loan, foreclosing on your home will cause your credit score to drop. Losing your home means that you have trouble making payments. Unfortunately, having a bad credit score will also impact your ability to get a home loan in the future.
Filing for Bankruptcy
Filing for bankruptcy is a serious move that should not be taken lightly. While it can help relieve debts that you can no longer pay, it also obliterates your credit score. According to the Fair Credit Reporting Act, a Chapter 7 bankruptcy will remain on your credit report for 10 years, while a Chapter 13 will remain anywhere between seven to 10 years, depending on your specific scenario. While you can recover your credit from bankruptcy, it will remain a blemish on your report for up to a decade.
Tips for Improving a Bad Credit Score
While a bad credit score can seriously impact your life, no credit score is hopeless. By changing the behaviors that create poor credit and taking proactive steps to improve your credit, you can eventually get to a good place with your score. Use these tips to improve a bad credit score.
Pay Your Bills on Time
Paying on time is essential for maintaining your score. If you struggle to make payments on time, consider setting up automatic payments or a reminder on your phone the day your bill is due. Paying on time doesn't just apply to credit card and loan payments, but also to your cell phone bill, electricity bill, rent, and other essentials.
Pay Off Debt
If you have outstanding balances on your credit cards, work to pay them off as quickly as possible. Every month that you have debt will impact your credit score. This will also help improve your credit utilization ratio.
Keep Your Balances Low
While it's important to maintain your credit history, use your credit cards lightly and keep your balance relatively low. Typically, lenders like to see utilization rates at a maximum of 30%. That means that the balance on your credit card should be no greater than 30% of your credit limit. For example, if you have a credit card with a credit limit of $15,000, then you should make sure that your balance on that card never exceeds $4,500.
Keep Your Accounts Open
Even if you don't intend to use a credit card any longer, simply pay off the balance and keep it in a secure place. Having the account but keeping the card stowed away will help maintain your credit history, without the burden of carrying the old card around in your wallet.
Don't Apply for New Accounts
While having a good mix of credit sources is desirable, don't apply for new credit cards or loans. This is especially true if you already have substantial debt. Applying for credit cards or loans will hit your credit with an inquiry, which can be damaging, and having more credit to play with can be harmful if you're having money management problems and will be tempted to spend.
Track Your Credit Score
If you're on a mission to turn your bad credit score into a good one, find a way to track your score without doing a hard credit inquiry. This will allow you to track your progress over time and see how your new behaviors are improving your score. Pick a tool that will do a soft credit check and make sure that you are always checking in with the same tool each month. This will ensure consistency since each tool will use different credit bureaus to determine your score. Use annualcreditreport.com to review your credit reports once a year, free.
Introducing TheStreet Courses:Financial titans Jim Cramer and Robert Powell are bringing their market savvy and investing strategies to you. Learn how to create tax-efficient income, avoid mistakes, reduce risk and more. With our courses, you will have the tools and knowledge needed to achieve your financial goals. Learn more about TheStreet Courses on investing and personal finance here.