How To Overcome Bad Credit
When your credit score is low, it is often difficult to obtain a loan from a financial institution. Credit scores are one of the first criteria banks use when assessing whether a borrower represents an acceptable risk. Some institutions never look past this score and will not lend if it is below a certain benchmark. There are also lenders that look at other indicators when deciding whether to lend to you, even if you have a low credit score. (For related reading, see 5 Keys To Unlocking A Better Credit Score.)
Full Credit Report
A credit score alone doesn't tell the whole story of your credit history. The full report will show a lender which credit products contribute to the score. Late payments will be shown by month, which will tell them whether it is a chronic problem or a one-time issue. For example, if you were late with credit card payments three months in a row two years ago when you were in the hospital, a bank can consider those mitigating circumstances when assessing your reliability, especially if you have been current with payments since.
Review of Recent Credit History
How you have handled credit in the past year is more important to lenders than how you handled it five years ago. If the damage to your credit score is old and you have a perfect payment history in the past twelve months, lenders are more likely to look favorably on your loan application. Your credit score will improve over time as it weighs recent history more heavily than old activity. Lenders may be able to lend before the score rises with enough details of recent credit history. (For more information, read How Credit Cards Affect Your Credit Rating.)
A bank's main goal is to ensure that its loan is recoverable. Pristine credit allows the banks some comfort that you will be able to return both the original amount of the loan plus interest. When your credit score is low, however, banks may require additional assurance. Collateralizing, or securing the loan with assets, gives lenders the ability to take your asset if you don't repay the loan. Some loans are automatically collateralized.
For example, your mortgage is secured by your home and your car loan is secured by the vehicle. If you have equity in your home or other assets that you own free and clear, a bank may be able to offer a secured loan, even if your score is low.
This loan product is becoming more common as the economy continues to struggle and more consumers are finding themselves with challenging credit scores. Secured deposits are most common with secured cards. These cards allow you to use credit and build back up your credit score. The card company requires that borrowers deposit money with them, usually 100% of the credit limit, which limits their risk. While this type of product doesn't let you take out new debt, it can help you re-establish your credit score quicker.
The Federal Housing Administration (FHA) is a government agency under the umbrella of the Department of Housing and Urban Development. The FHA runs a mortgage program that guarantees mortgages of eligible homeowners. If the loan goes into default, the FHA reimburses the lender. Due to the FHA guarantee, banks can often lend to homeowners who would not otherwise qualify under conventional loan programs.
The Bottom Line
A poor credit score can seriously damage your ability to get a loan or refinance your existing loans. Some lenders, however, can look at your entire financial situation more holistically to determine if you are a reasonable credit risk. Keeping your current credit situation under control is the first step in rebuilding your credit history. (To learn more, check out What Credit Score Should You Have?)