Before diving into all that a bad credit score entails, first things first:
What are credit scores?
Credit scores are three-digit numbers that represent your financial behavior. Scores range from 300 to 850, with the latter being the highest possible score. Banks and other lenders rely on this rating when considering whether they should enter a business venture – such as a loan or a line of credit – with you. The higher your score, the more likely they'll approve your application, be it for a mortgage or a new credit card.
There are multiple methods to calculate scores, but the most popular is the FICO model. Generally, a rating of 700 or higher is a "good" credit score.
Read on to learn more about credit score classifications, the causes of poor credit scores, and how they can impact you.
What's a bad credit score?
Credit scores fall into five categories: poor, fair, good, very good, and excellent. FICO is the most well-known and widely used computation model. FICO scores range from 300 to 850. The lowest possible score is 300, while 850 is the highest.
A poor score is 300–579, fair is 580–669, good is 670–739, 740–799 is very good, and 800–850 is excellent.
As a general rule, a "bad" FICO score is anything below 670. Ultimately, any score classified as "fair" or "poor" is not ideal.
FICO gathers information from the three major credit bureaus: Equifax, Experian, and TransUnion.
VantageScore is another popular credit scoring model that also ranges from 300 to 850. Because they emphasize different pieces of information, your VantageScore credit score may differ slightly from your FICO score. That said, a "bad" VantageScore score is below 601.
Remember, everyone has multiple credit scores depending on the algorithm used to compute them, and that's perfectly okay.
What factors influence your credit score?
While an array of factors influence your score, there are five main factors to remember.
One: Payment history accounts for 35 percent of your score. Payment history is the most influential factor in FICO and VantageScore calculations. Paying your bills on time will positively affect your score while paying them late or skipping them altogether will do the opposite.
Two: Accounts owed, also called credit utilization, accounts for 30 percent of your score.
Three: Credit history length typically refers to loans and makes up 15 percent of your score. Younger people usually begin to build their credit scores this way through student loans.
Four: New credit – specifically applying for, and by extension, being rejected for too many lines of credit – makes up 10 percent of your overall score, and it can be a severe detriment to your score.
Five: Credit mix, which refers to having various credit types such as credit or debit cards and loans, constitutes 10 percent of your score.
It's important to remember that building your credit history takes time, and once you do, your score will fluctuate. Credit scores are dynamic, just as your spending and payment habits change from month to month, too.
How a bad credit score can impact you
Higher scores can open more doors for you financially, whereas low credit scores suggest irresponsible behavior. So, suppose a bank chooses to enter a lending relationship with you by approving you for a home mortgage. In that case, a lower score means you will most likely face more restrictions and fees, would-be collateral that justifies the risk a lender assumes by approving you for a loan or line of credit.
Read on to learn about some of the consequences you may face due to a a poor credit score.
Denials for lines of credit
This includes a lender rejecting your application for a mortgage, auto or student loans, or for new credit cards.
Less favorable loan terms
What this typically entails is higher and more frequent interest installments. The loan itself may be smaller in volume, too. Better credit scores can lead to lower fees all around.
Limited credit card choices
Individuals with good credit scores are more likely to have access to credit cards with rewards programs, such as cash-back points on purchases or subscriptions, whereas those with poor credit scores generally do not.
Difficulties with rental application approval
Like banks and other lenders, landlords check your credit history as part of their evaluation process whenever you submit a lease application. A low score suggests that you'll likely have difficulty paying rent. According to Experian, a score of 620 is the minimum score needed to apply to rent an apartment. But every landlord is different — some are stricter than others.
Mandatory security deposits
Security deposits usually apply to utilities, such as electricity, water, and gas. Low credit scores mean you're more likely to have to pay an up-front deposit before you contract these types of essential services. The deposit acts as insurance in the case that you are unable to pay your bill.
Issues during an employment background check
Unfortunately, your credit score not only represents your past financial history, but it suggests how you're likely to act in the future as well. Some employers will even check your credit score before hiring you. While your potential new boss won't receive every detail, they can access a report summarizing your spending habits and bill payment. So, if you're applying to a finance-focused job, a bad credit score could mean losing out on the position.
Higher auto insurance premiums
Like banks do with loans, individuals with poor credit scores must pay higher insurance costs because they are a risk. If something happens while you have the car, you will face steeper liability fees.
How to improve a bad credit score
Again, your credit score will naturally change over time. There is no perfect score. What matters most is diligence and handling your money wisely.
Nonetheless, certain strategies can help increase your score.
Tip 1: Check your credit score annually. This is perhaps the easiest and simplest thing you can do to help improve your score. If you don't know your score, you can't fix it. You're entitled to a free credit score from any of the three credit bureaus once a year. It's important to know that checking your score does not influence your score. As the saying goes, knowledge is power, so it's better to stay informed than to live in ignorance.
In addition to knowing your score, credit reports can help you recognize your spending habits and help you budget better.
Tip 2: Review your credit reports.
Mistakes happen, even with credit scores. Knowing your financial habits is one thing. But you also must monitor your credit report and take action by addressing any errors that you notice as soon as possible. In the case of an error, you can submit a dispute to the credit bureaus.
Tip 3: Pay your bills on time. This is essential because it increases your reliability in the eyes of banks and lenders and will positively impact your score in a significant way. One strategy to keep in mind is setting up automated payments to avoid missing deadlines.
Tip 4: Pay off your debt. Reducing your debt is the second most influential factor in improving your credit score. Ensuring that you pay your periodic installments in a timely fashion will keep you from having to pay penalties and compounding interest fees. According to experts, you should use no more than 30 percent of your credit limit.
Tip 5: Know the difference between soft and hard inquiries, and avoid the latter. There are two types of credit inquiries: hard and soft. Examples of hard inquiries include when lenders check your credit as part of an application, like a credit card or a car loan, affecting your credit score. A typical soft inquiry is when you check your credit score, which does not affect your credit score.
Remember, hard inquiries affect your credit score. Soft inquiries do not.
Tip 6: Seek assistance in building your credit. This is never a bad idea, and there are multiple ways to go about it.
One option is to look for a trusted friend or family member who has good credit to act as a cosigner when applying for a loan.
You can also apply for a secured credit card, which requires a deposit that is usually equal to the line of credit. Afterward, you can use it just like any other traditional credit card, but you still must make monthly payments.
Another option is Point Card. You work hard for your money, and Point works hard for you in return. Point Card is an alternative tool for those who want to use their own money while receiving exclusive benefits, including unlimited cash-back on all purchases. As a cardholder, you receive bonus cash-back on subscriptions, food delivery, rideshare services, and coffee shops. Plus, Point Card comes with car rental and phone insurance, not to mention travel benefits and zero-liability fraud protection.
Tip 7: Keep your old credit cards open, active, and in good standing. Believe it or not, it's better to keep an account open and not use it instead of closing it altogether. Canceling a card will cause you to lose any positive credit history and contributions you made to your score.
Why good credit scores are important
These days, a good credit score is crucial to achieving your financial goals, whether you're buying a house, financing a car, going back to school, or taking out a personal loan. Establishing and maintaining a good credit score indicates intelligent, diligent financial behavior that will go a long way in the eyes of potential lenders.
Remember, there is no "perfect credit score," and your financial situation will vary over time. But making an effort to improve your credit score is never a bad thing. And, if you're unsure where to start, checking your score annually and seeking advice from a professional is a great way to begin.
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