The Basics of Bad Credit
Credit scoring predicts borrower behavior Until recently, bad credit was something of a
mystery. That’s because there was no uniform, statistical way of measuring people’s credit behavior. A few years ago, however, a company called Fair Isaac Corporation developed a uniform credit scoring method called the FICO score. Because each of the major credit bureaus (Experian, Equifax, and TransUnion) have different information about you, your FICO score established by each of these companies will differ somewhat. You FICO score is one of the best indicators of how good or bad your credit is. To come up with your score, the information in your credit report is compared mathematically to the credit report information of millions of others. Your future credit behavior can more easily be predicted based on this data. Most lenders use the FICO score as a starting point when deciding whether or not to extend credit to you.
Low scores: the good news
Having a lower FICO score doesn’t mean you won’t be able to borrow money. In the past, before credit scoring became standardized, many lenders were hesitant to take any risks at all. They were not good at predicting who would default on a loan and who would not. They would see one negative item on a credit report and simply refuse to extend any credit at all to some individuals. Today, however, even borrowers who have problems in their credit history have access to credit. Standardized credit scores and statistical models allow lenders to predict borrower behavior more accurately. As a result, many companies now offer a wide variety of credit programs tailored to individuals of varying risk levels. High-risk borrowers who may not have qualified for credit in the past are now more likely to do so. Lenders usually charge those individuals higher interest rates.
Credit scores: the good, the bad, and the average
FICO credit scores range from a low of 300 to a high of 850. The higher your score, the better. According to Experian, one of the three major credit reporting bureaus, the average American credit score is 677. Fair Isaac suggests that to qualify for the most favorable lending terms, including the lowest interest rates, you need a score of 720 or higher. The three major credit bureaus, as well as the Fair Isaac Corp. and other companies, will make your credit score available to you for a fee.
The most important factor: your payment history
Many factors go into determining your credit score, but some factors are weighed more heavily than others. The most important factor is your payment history, which accounts for approximately 35% of your credit score. Payment history includes payment information on credit cards, mortgages, auto loans, and other loans. Missing payments or making late payments will affect your credit score negatively. Bankruptcy or other financial judgments against you also have a negative impact on your score.
Other factors affecting your credit score
The amount of money you owe, how much credit you have available to you, and the proportion of credit balance to total credit limit all affect your credit score. The length of your credit history is also important. Having a long, good credit history is obviously better than having a short credit history. Also taken into account is recent credit activity (such as applying for a new credit card) and the type of credit you have used in the past (credit cards, installment loans, consumer finance loans, etc.)
What to do if your credit score is low
Your credit score is not the only criteria a lender looks at when deciding whether or not to give you credit, but it is a major factor. Most lenders also look at your credit report, which gives details about your credit behavior. If you can show that your most recent payment history is good, despite past credit problems, many lenders will give you credit. Making a sincere effort to manage your credit responsibly will help to raise your credit score over time. Lenders each have their own guidelines and criteria for granting credit. In some communities, it pays to get to know your local lenders personally. Once they get to know you, they may feel more comfortable giving you credit even though your score is not as high as they would like.
The bottom line? Just because you are turned down for credit by one lender doesn’t mean they all will. Some credit companiesspecialize in working with people who have past credit problems. It pays to shop around.
TIP: Do not be fooled by companies claiming to raise your credit score over a few days. You must be patient and persistent if you wish to improve bad credit.