Many people feel that society looks down on them for having a bad credit score. Unfortunately, for the most part, that’s a true statement. This can sometimes be unfair, as there are many reasons why someone could have damaged their credit. Medical bills or the loss of a job, for example, can put someone in a difficult financial situation through no fault of their own. Or, perhaps, someone made mistakes or acted irresponsibly when they were young. The reality is that credit problems don’t go away easily; they’ll typically stay on your credit report for a long time.
If you have a bad credit history, it hardly matters now how you got there, but it’s important to understand what makes up your credit history and how your credit score can affect your ability to make financial moves in the future. Knowing this information can help you do the right things to help repair your credit and build a good history going forward. As a start, you can learn some of the basics about credit scores and some of the terminology associated with a credit reporting.
What’s the Difference Between a Credit Score and a Credit Rating?
Many consumers believe that a credit score and a credit rating are the same thing. While they’re similar, they’re not exactly the same thing. Credit scores generally refer to individuals while credit ratings are used when grading a business. There are several ways to rate businesses but the most widely used rating system has grades ranging from AAA all the way down to D, which means default. This rating system is used to determine or predict the creditworthiness of businesses and if they’re likely to pay their bills on time and according to terms. Three primary companies rate businesses: Moody’s, Fitch, and Standard and Poor.
Credit scores are in place for lenders to evaluate the creditworthiness of individuals. This allows lenders to make sound decisions on whether they should extend credit. Most lenders use a consumer’s FICO score, which can fall anywhere between 300 and 850. The higher your score, the better your credit picture is.
While FICO is the most commonly used system to determine your creditworthiness, three credit bureaus track your credit history: Experian, TransUnion, and Equifax. The reports they produce are not always identical, as the information they gather can vary. In addition, the methods they use to calculate your score are different, so don’t be surprised to see a range of scores.
How Does Having a Poor Credit Score Affect You?
If your credit score is low, you’ll suffer some definite negative effects. For example, you may not be able to qualify for a mortgage or for another type of loan that you need. If you’re approved for a loan with bad credit, you’ll most likely have to pay a much higher interest rate. This could significantly raise your monthly payment and the cost of the item you’re purchasing over the long haul. If you’re in deep credit card debt, however, sometimes it’s better to take a higher interest loan so you can consolidate and pay off your debt.
If you’re trying to get approval for a mortgage, having a bad credit score isn’t necessarily going to keep you from getting a loan to purchase a home. There are options for borrowers who have lower scores and different loan products have different requirements when it comes to credit scores. To get an FHA loan, for instance, you’d need a minimum credit score of 580. If your score is lower than that, you’ll fall into a loan category known as “subprime.” This will most likely mean that your loan comes with a higher interest rate and other requirements such as a higher minimum down payment.
To qualify for what’s known as a conventional loan, you need a minimum credit score of 620. If you’re able to put a 20% or more down payment down on your home, you won’t have to pay for private mortgage insurance (PMI). For an FHA loan, if you make the minimum down payment of 3.5%, you’ll have to pay PMI for the entire duration of the loan. However, if your down payment is 10% or more, you’ll only have to pay PMI for the first 11 years of the loan before it drops off automatically.
If you live in a rural area, you might be able to get a USDA loan. USDA loans require a credit score of 620 or more. The best part is that you won’t have to make a down payment with a USDA loan if the home you want to buy qualifies by being in an approved rural area. If you’re a veteran, you may have the option of a VA loan. While different lenders have different requirements, most lenders require a score in the 620 range. With a VA loan, there’s no down payment required.
What Type of Information Can Affect Your Ability to Qualify for a Mortgage?
When it comes to getting a mortgage, you should know what information could affect your ability to qualify. Any lender that’s considering giving you a mortgage will look into your past payment history if you’ve ever had a previous mortgage. If you were late with your payments, that can have a negative effect, especially if you were late several times in a 12-24-month timeframe. Every lender has a different set of criteria, but you get the idea.
If you have any judgments or liens filed against you, you’ll most likely be required to pay them off before you can be approved for a mortgage. If you have a bankruptcy or a foreclosure in your past, it may be some time before you’re able to get a new mortgage.
Understanding Credit Scores
Having a good understanding of where your credit score stands, as compared to others, is important. Credit scores fall into ranges that can give you a general understanding of where you stand. Here’s an overview of the credit score ranges:
300-579: Poor Credit or New Credit
580-620: Poor to OK credit
621-740: Good Credit
741+: Very Good to Excellent Credit
Poor Credit or New Credit
If your credit score falls into the range of poor or new credit, you’ll need to take some action to build up your credit if you want to be able to qualify for car loans, credit cards, or a mortgage. If you have no credit at all, you might want to start with a secured credit card. A secured card will require you to make a monetary deposit as security for the card. The lender will establish your card limit based on the amount of money you have on deposit. If you don’t make the payments required on the card, the lender will simply use your deposit to cover the missed payment. The lender is not taking a risk, and having a secured card can give someone with a poor or non-existent credit history the chance to build some positive results. Once you’ve proven yourself over several months, you can apply for an unsecured credit card.
If your credit score is poor, it’s important to take a hard look at your credit report to make sure it’s accurate. If it isn’t, start the process of disputing any item that doesn’t belong to you or is incorrect. Don’t forget that you can get your credit report from TransUnion, Experian, or Equifax, free, through AnnualCreditReport.com, once per year for each. This is something you should take advantage of to make sure your credit report contains accurate and up-to-date information.
If you have any collections or charge-offs on your credit report, these will have an impact on your credit score. If you let your debt age past 90 days, it’ll most likely go into collection, which means it’ll most likely be outsourced to a collection agency. These agencies will pursue you and try to collect payment on the account for the creditor. If you have a collection account, it may remain on your credit for a period of seven years. That’s a long time to have it affecting your credit score.
If you fail to pay an account in collection, it’ll eventually be charged off by the lender. Often, these debts will be sold off to other agencies that’ll continue to try to collect that debt from you. It’s possible that you’ll be offered a settlement amount to clear the debt. Paying off collections and charge-offs can help improve your credit score, but the best thing to do is never let them get into collection in the first place. These items, even when paid, can show up on your credit report for seven years.
When paying off your collection or charge-off amounts, it’s advisable to first notify the agency trying to collect your debt. You can often negotiate the removal of the information from your credit report.
Improving Your Credit Score from OK to Good
Improving your credit score should always be the goal; luckily, there are things you can pay attention to that may help take things up a rung or two.
When your FICO score is calculated, several different factors are used to determine your score. The largest influencer is your payment history, as lenders feel this is the most reliable indicator of your future behavior. Your payment history makes up 35% of your FICO score, so making your payments on time is essential to improving your score. Although most lenders don’t report your payment as late until 30 days have passed, do your best to make your payments on time so you don’t incur any late charges or increases in your interest rate.
Another way to improve your credit score is to pay down the balances on your accounts to 30% or less of your credit limit. This factor accounts for 30% of your credit score. While carrying a zero balance is not necessary for a good credit score, it’s always best to try to pay off your credit card balances in full every month if you can. Otherwise, you’re just paying unnecessary interest to the credit card companies.
You should also be reviewing your credit report periodically for any evidence of fraud. If you do find anything that looks suspicious or is definitely fraudulent, make sure you know what steps to take. You should also request that the credit bureaus institute a fraud alert on your account so you’ll be notified if any accounts or loans are established in your name.
Other things you can do to help improve your credit score are to try to diversify the types of accounts you have and to minimize the number of credit inquiries you make. However, you can inquire into your own credit without affecting your score, so don’t let that hold you back from checking your credit reports regularly.
Having less-than-perfect credit doesn’t mean you can’t achieve the dreams you set out to realize. If you’re new to credit, do the right things to build it well. If you’ve had setbacks, there are ways to get back on track. Bottom line: if you’re paying attention to your credit picture and working toward improving it, there’s nowhere to go but up!