What Is Bad Credit?
Bad credit refers to a person’s history of not paying bills on time and the likelihood that they will fail to make timely payments in the future. For individuals, it is often reflected in a low credit score. Businesses can also have bad credit.
Having bad credit makes it difficult to borrow money, especially at competitive interest rates.
Key Takeaways
- A person or business is considered to have bad credit if they have a history of not paying their bills on time or they owe too much money.
- Bad credit for individuals is often reflected in a low credit score, typically under 580 on a scale of 300 to 850.
- Would-be borrowers with bad credit will find it harder to get a loan or obtain a credit card.
Understanding Bad Credit
Most Americans who have ever borrowed money or signed up for a credit card will have a credit file at one or more of the three major credit bureaus: Equifax, Experian, and TransUnion. The information in those files, including how much money they owe and whether they have paid their bills on time, is used to compute their credit score, a number that's intended as a guide to their creditworthiness.
The most common credit score in the United States is the FICO Score, named for the former Fair Isaac Corp., which devised it.
A FICO Score is made up of five major elements, assigned different weights:
- 35%—payment history: This factor is given the greatest weight. It indicates whether the person has paid their credit bills on time. Missing by just a few days can count, although the more delinquent the payment, the worse it is considered.
- 30%—total amount owed: This includes mortgages, credit card balances, car loans, any bills in collections, court judgments, and other debts. What’s especially important here is the person’s credit utilization ratio, which compares how much money they have available to borrow (such as the total limits on their credit cards) to how much they owe at any given time. Having a high credit utilization ratio (say, above 20% or 30%) can be viewed as a danger signal and result in a lower credit score.
- 15%—length of credit history: Longer is better.
- 10%—mix of credit types: This can include mortgages, car loans, and credit cards. Having several types is a plus.
- 10%—new credit: This includes any credit that the person has recently taken on or applied for. Lenders can consider it a red flag if you’re applying for a lot of credit.
Examples of Bad Credit
FICO Scores range from 300 to 850, and borrowers with scores of 579 or lower are generally considered to have bad credit. According to Experian, about 62% of people with scores at or below 579 are likely to become seriously delinquent on their loans in the future, making them poor risks for lenders.
Scores from 580 to 669 are labeled as fair. These borrowers are substantially less likely to become seriously delinquent on loans, making them much less risky to lend to than those with bad credit scores. However, even borrowers within this range may be forced to pay higher interest rates or have trouble securing loans at all, compared with borrowers who are closer to that top 850 mark.
How to Improve Bad Credit
If you have bad credit (or fair credit), there are steps you can take to get your credit score above 669—and keep it there. Here are some tips for accomplishing that, straight from FICO.
Set Up Automatic Online Payments
Do this for all of your credit cards and loans, or at least get on the email or text reminder lists provided by the lenders. This will help ensure that you remember to pay at least the minimum on time every month.
Beware of advertised “quick fixes” to your credit score. Experts warn that there’s no such thing.
Pay Down Credit Card Debt
Make payments above the minimum amount due whenever possible. Set a realistic repayment goal and work toward it gradually. Having high total credit card debt damages your credit score, and paying more than the minimum due can help raise it.
Check Interest Rate Disclosures
Credit card accounts provide these disclosures. Focus on paying off the highest-interest debt fastest. This will free up the most cash, which you can then begin to apply to other, lower-interest debts.
Keep Unused Credit Card Accounts Open
Don’t close credit card accounts that you no longer use. Also, don’t open new accounts that you don’t need. Either move can damage your credit score.
If bad credit has made it difficult for you to get a regular credit card, consider applying for a secured credit card. It is similar to a bank debit card, in that it allows you to spend only the amount you have on deposit. Having a secured card and making timely payments on it can help you rebuild a bad credit score and eventually qualify for a regular card. It also is a good way for young adults to begin to establish a credit history.
How Long Does It Take to Repair Bad Credit?
This depends on how bad your credit score is to start. If you’re recovering from a bankruptcy, it can take years to build up a good credit score. However, paying down debt to decrease your credit utilization ratio can have an impact in as little as a couple of months. And be sure to keep paying your credit bills on time.
Can I Open Too Many Credit Cards?
There’s no set limit on how many lines of credit you can have open at one time. However, applying for too many cards in a short period can hurt your credit score. Consider how much credit you actually need before opening a new card account.
What Is the Most Important Factor in My Credit Score?
Your payment history is the single most important factor in your credit score. Paying on time every month will have the biggest impact on your credit history. Missing payments can lower your score quickly and significantly.
The Bottom Line
Bad credit can be a major roadblock, especially if you hope to borrow money to purchase a home or a car. But it doesn’t have to be permanent.
If you have bad credit, paying your debts on time and paying down high balances can improve your credit score and make you more attractive to lenders. If you feel like you’re drowning in debt, a nonprofit credit counselor may be able to help.
