Bad credit is a phrase that gets thrown around a lot. Everyone knows that bad credit is bad for you. But, in order to fully understand how it is bad for you and what you can do about it, you need to really understand what it is.
Understanding Bad Credit
A person’s credit history is an indication of their credit risk. It is a number that is primarily used by creditors to determine whether they will approve a loan and what the conditions will be on the loan. A low credit score indicates bad credit, while a high credit score indicates good credit. There are a number of factors that are considered when it comes to working out a person’s credit score, with each factor having a specific weight in determining the final score.
How Credit Scores are Worked Out
All credit scores in the United States are calculated by the Fair Isaac Corporation (FICO). It collects information from three credit bureaus – Equifax, Experian and TransUnion – weighing each aspect of the information to determine the final score.
- Payment history – this is given the most weight, constituting 35% of the score. It focuses on whether past payments were made on time.
- Amount owed – this constitutes 30% of the score. It includes all debt, such as student loans, mortgages, credit cards and any other debts owed.
- Length of credit history – this makes up 15% of the score. This looks back to the oldest debt on the list.
- Mix of credit – this makes up 10% of the score. This considers how many debts the person has, with the fewer types of debt resulting in the lowest score.
- New credit enquiries – this makes up 10% of the score
Credit scores from FICO range from 300-850. Scores below 579 are considered to have bad credit, while scores between 580 and 669 are considered to have fair credit. Any score over 700 is generally considered to have good credit. In most instances, when you are applying for a loan, the creditor will check your credit score to determine your credit risk. This will directly impact the terms and conditions you are offered. Personal or business loans for bad credit typically have high interest rates and short terms. In fact, people with bad credit will often struggle to get approval for a loan at all.
Dealing with Bad Credit
If you have bad credit, dealing with it should be a priority for you. Bad credit impacts many aspects of your life, not only applications for a loan. More and more landlords are requesting credit checks and even potential employers might ask for one. In addition, having bad credit will cost you a lot of money in the long term with the poor loan conditions you are offered. Analyze your credit reports to see which debts are costing you the most. Pay off any debts that are past due and then pay off your debts with the highest interest rates. This is a slow process, but will be worthwhile in the end.