What Is Bad Credit?

Bad credit is a description of a person or a company's predicted inability to repay a debt on time and in full. It is based on the individual or company's past history of paying off debt and related personal finance factors.

Anyone who ever takes out a loan, uses a credit card, or pays a bill over time has a credit history. This history is summarized with a score that indicates the borrower's credit risk. A low credit score signals bad credit, while a high credit score is an indicator of good credit.

A person who has bad credit will find it difficult to get approved for a new loan, or at least will be offered credit only at a very high rate of interest.

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Unexpected Things That Lower Your Credit Score

How Credit Score Is Determined

A credit score is intended to provide a snapshot of a person's creditworthiness. In the United Scores, the Fair Isaac Corporation (FICO) calculates credit scores using information from three credit bureaus: Experian, TransUnion, and Equifax.

The FICO credit score is made up of a number of elements:

  • Payment history is given the greatest weight, more than a third of the total. This simply indicates whether payments are made on time. (Missing by just a few days counts.)
  • The total amount owed by the individual is another third. This includes mortgages, credit cards, car loans, any bills in collections, judgments, and other debts owed by the individual.
  • Smaller amounts are split among the person's length of credit history, mix of credit, and recent history of new credit inquiries. Length of credit history takes into account the oldest account noted on the credit report. Credit mix is a count of how many debts a borrower has. Credit inquiries take into account whether the person may be considering taking on additional debt.

Other important factors that affect credit scores are credit utilization (30%) and average age of credit accounts (15%).

Good and Bad Credit Scores

FICO scores range from 300 to 850. Traditionally, borrowers with scores at or below 579 are considered to have bad credit. According to Experian, 61% of borrowers with scores at or below 579 are likely to default or become seriously delinquent on their loans in the future.

Scores between 580 and 669 are labeled as fair. Only 28% of these borrowers are likely to become seriously delinquent on loans, making them considerably less risky to lend to than borrowers with bad credit scores. However, even borrowers within this range may face higher interest rates or have trouble securing loans, compared with borrowers who are closer to that top 800 mark.

90%

The approximate percentage of lenders that use FICO scores to make their credit decisions.

How to Fix Bad Debt

Clearly, the goal is to get your credit score above 669 and keep it there. Here are some tips for getting it done, straight from FICO:

  • Beware of advertised "quick fixes" to your credit score. FICO warns that there's no such thing.
  • Set up automatic online payments for all of your credit cards and loans, or at least get on the email reminder lists provided by the banks. This will help you ensure that you pay the minimum on time every month.
  • Gradually pay down your credit card debt by making payments above the minimum due whenever possible. Set a realistic repayment goal and work towards it. High total credit card debt damages your score. Paying above the minimum due raises your score.
  • Check the interest disclosure on your credit card accounts. Pay the highest-interest debt off fastest. This will free up the most cash.
  • Don't close unused credit card accounts or open new ones you don't need. Either move can damage your credit score.

Once you minimize your debt, you'll want to establish a history of good credit:

  • Get a secured credit card. This is similar to a debit card, in that it allows you to spend only the amount you have on deposit. It will help you rebuild a bad credit rating. It also is a good way for young adults to establish a credit history.
  • Start using a credit card responsibly. Pay off your debt in full every month. Your credit rating will soon reflect this new personal financial history.

Key Takeaways

  • Bad credit is the term used to describe a person or company's predicted inability to repay a debt on time and in full.
  • In the U.S., FICO calculates credit scores based on information from the three credit reporting agencies.
  • On a scale of 300 to 850, a credit score of 579 or below is considered bad credit.
  • A history of repaying debt on time and in full is necessary to maintain good credit.
  • Bad credit history can be repaired by paying off old debt, taking on moderate new debt, and managing it responsibly.