It can be depressing when you’re at the bottom of the credit scale, but it doesn’t have to stay that way.
You can increase your bad credit rating if you use the right techniques and persist. And I promise you, it won’t take the rest of your life to build a solid credit rating either. So let’s get started.
What is considered bad credit?
Here’s a broad definition: A consumer who has bad credit, also called bad credit, has a FICO score of 579 or less. With a bad credit rating, you might only be approved for credit cards, mortgages, or personal loans with high interest rates. But consider this a temporary problem. Once you start working on your score, your ability to earn credits will improve.
Understanding how credit scores work can help you make better credit decisions. There are two credit scores that are most often used by lenders: FICO scores and VantageScores. FICO also offers score versions for different industries.
About 90% of lenders use some version of the FICO score to help determine an applicant’s creditworthiness. FICO Score 8 seems to be the most used version, but there are also newer versions, such as FICO Score 9 and FICO Score 10. It takes a long time for lenders to use a new score, that’s why FICO Score 8 is still popular.
FICO scores range from 300 to 850. According to myFICO.com, here are the values for each credit score range:
- Exceptional: 800 and more.
- Very good: 740 to 799.
- Good: 670 to 739.
- Correct: 580 to 669.
- Poor: 579 and below.
As you can see, the bad credit score range for FICO is 579 and below. The average FICO score in April 2021 is 716, which is considered good credit. A bad FICO score is a bit below average. Improving your score may seem impossible right now, but having good credit will be within reach after spending time rebuilding your credit.
Let’s take a look at the factors that make up the FICO score:
- Payment history: 35%.
- Amounts due: 30%.
- Length of credit history: 15%.
- New credit: 10%.
- Loan composition: 10%.
If you have a bad credit score, it means that lenders think you have a high risk of delinquency. In fact, about 61% of consumers with credit scores below 580 are likely to become delinquent on a credit-related account, according to FICO. This is why it is difficult to get approved for credit without paying high interest rates.
VantageScore ranges from 300 to 850, just like the FICO score. But because VantageScore rates options a little differently, a FICO score of 700 cannot be directly compared to a VantageScore of 700. Also, FICO scores have different ranges for each credit score.
Here are the VantageScore ranges:
- Excellent: 750 to 850.
- Good: 700 to 749.
- Correct: 650 to 699.
- Poor: 550 to 649.
- Very bad: 300 to 549.
As you can see, there are two categories that could be considered part of the bad credit score range. With VantageScore, bad credit is 550 to 649. And very bad credit is below 550. You will need a score of 650 to fall into the fair credit score range.
Rather than using percentages like FICO does, VantageScore focuses on the influence of each factor in the algorithm. The factors that make up the VantageScore include:
- Available credit, balances and use of credit: extremely influential.
- Mix of credit and experience: very influential.
- Payment history: moderately influential.
- Age of credit history and new accounts: less influence.
How bad credit affects you
The impact of a poor credit rating, regardless of the rating used, can be significant. You will pay high interest rates when you apply for credit. And that’s assuming you can get approved for credit. Bad credit can make it difficult to buy a house, rent an apartment, or even set up utilities.
Bad credit can also lead to higher auto and health insurance rates in some states. And if you apply for a job with an employer who wants to see your credit report, it will most likely be obvious that you have bad credit from the items listed on your report.
But there are ways to get started on the path to good credit. It takes time, but perseverance will help you get there.
How to Fix Bad Credit
Now that you know more about how credit scores work, your short-term goal is to move to fair credit, which for FICO is 580.
Your long-term goal? To get the lowest interest rates, you’ll need a FICO score of at least 760, which puts you in the very good FICO score range. It won’t happen right away, of course, but it’s a possibility if you use one or more of the following strategies.
Set a budget and track expenses. If you don’t have a budget, you need to set one today. Once you’ve gotten this sorted, you also need to track your spending, which is easy to do with a free app or online money management tools.
It’s hard to stay on budget if you don’t know how much you’ve spent and where you’ve spent it. Getting into debt or increasing the debt you already have could worsen your credit score. So consider this as your financial base. A solid foundation helps you build good credit.
Get a secure credit card. With a bad credit score, you will have a hard time getting a decent credit card approved. Before you decide to get an unsecured credit card with a high annual percentage and monthly maintenance fees, take a look at secured credit cards.
You will need to put down a deposit to guarantee the credit card. But you’ll get a normal-looking credit card to use for purchases. These cards are listed on your credit report as a revolving credit account, and as long as your issuer reports your payment history to the credit bureaus, you’ll get a better credit score. In other words, as long as you use the card responsibly.
Many people don’t know this option exists. You can check with your local bank or credit union to see if credit loans are offered. Each institution has its own set of rules and rates for credit loans, but typically the bank or credit union creates a locked deposit account that holds a small amount, such as $1,000.
You then repay the “loan” in monthly installments. This type of loan is identified as an installment loan by the FICO score algorithm, which also gives you a little boost in the “credit mix” category.
You have a credit utilization ratio, which is the amount of credit used compared to the amount of credit available. If you carry balances on your credit cards from month to month, your ratio could be high.
A ratio above 30% can lower your credit score. As you pay off your debts, your credit score will begin to rise. As stated earlier, available credit is 30% of your credit score. To get the biggest positive impact on your score, keep your balances under 10%.
How to maintain a good credit rating
If you make it a priority in your life to maintain good credit, you will reap a lot of financial benefits. You’ll get better interest rates, get approved for better credit cards, and save money on mortgages.
- Pay your bills on time. Payment history accounts for 35% of your FICO score. Be consistent with timely payment habits, and you’ll see it reflected in your credit score.
- Keep utilization rates low. You learned about credit utilization ratios in the previous section. Once you have paid off your debts, your ratio decreases, which improves your score. Remember this: Debt reduction helps you fix bad credit. But even after paying off credit card debt, maintaining a 10% ratio on each credit card helps you turn a good score into a great one.
- Do not close credit cards. Closing a credit card negatively impacts your score. Here’s why: When closing a card, you lose available credit. This increases your credit utilization rate, which can lower your credit score.
- Spread out credit card applications. Each time you apply for a credit card, the issuer does a thorough investigation to review your credit report and score. Your score may drop between two and five points for each application. A serious request stays on your report for two years, but it no longer impacts your score after it has been on your report for 12 months. So wait about four to six months after applying for a credit card before applying for a new card.
It is also important that you stay away from credit card debt. It is very difficult to have a high credit rating if your credit usage is high due to debt. Have a budget for each credit card you use and pay the balance by the due date each month. Stick to your budget and you won’t run the risk of going into debt.