Bad Credit Ratings

FICO Score
  • Understand why a good credit rating is important.
  • Examine how your credit score is calculated.
  • Review steps you can take to improve your bad credit.

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Understanding the Effects of a Bad Credit Rating

Do you have bad credit? If so, you are not alone. Millions of Americans have credit problems. A bad credit rating can prevent you from buying a house, renting an apartment, qualifying for a credit card, buying a car, or even opening accounts with cell phone providers or local utility firms. Even if you qualify for these kinds of accounts, your bad credit will cost you money. Lenders will charge you higher interest rates, if they are willing to work with you at all.

Don’t let your poor credit get you down or hold you back. Instead, take the right steps in order to improve your credit. Even if you just completed a bankruptcy, you can work your way to a strong credit rating in a few years time.

View Your Credit Report

An important initial step to improving your poor credit rating is to understand how your credit was damaged in the first place. Begin by viewing your credit report. Your credit report is record of your credit accounts that includes balances, credit limits, and payment history. It is compiled by the credit bureaus and is used by creditors to predict the likelihood that you will repay your debt. Lenders use information from your credit report to decide whether to extend credit to you and what rate to charge if they do lend to you.

Check it for accuracy and examine the derogatory information that appears on it. If there are errors on your credit report, take the proper actions to dispute them. You don’t want your credit score to suffer from mistakes that appear on your report.

You can get a free credit report from each of the three main credit bureaus (Experian, Equifax, and TransUnion) once a year, at AnnualCreditReport.com. These free credit reports do not include your credit score, but do contain all the information that each bureau reports on you. If you want to know your credit score, you can get a “free” credit report with a score online, from one of many firms that offer them. These firms are trying to sell you some service, such as credit monitoring. The services are not free, in that you have to pay a fee to obtain your score and sign up for some kind of service. Practically, however you can get the report at no real cost, as you can generally cancel their services after obtaining your free report and score, without any obligation, as long as you cancel within a one to two week introductory period.

Payment History

Now that you have a credit report in hand, in order to improve your score, you need to understand how your credit score is calculated.

The largest variable in determining your credit score is your payment history. Payment history counts for approximately 35% of your score. Have you missed payments? For the purposes of your credit score, being one day late on your payment does not degrade your score. It is when you reach 30 days late that the late payment will show on your report. The report shows the late payments in increments of 30 days (30 days late, 60 days late, 90 days late, etc.), until the account reaches charge-off status. Charge-off (sometimes called "write-off") is an accounting term used by creditors when they move a delinquent account from its accounts receivable books to its bad debt ledger. This usually occurs between 180 and 240 days from the date of the last payment. Collection efforts continue after charge-off, though the debt may pass into the hands of a third-party debt collector.

If you have one or two 30 day late payments, it is not disastrous. However, if you have an extensive history of delinquent payments or one or more of your accounts went into severe delinquency, then the impact on your score will be strong. Charge-offs, repossessions, accounts that have been sent to a collection agency, and foreclosures ding your credit report seriously. In addition, your score will suffer from entries on your credit report that appear in the “public records” area of your report. Bankruptcies, liens filed against you, and judgments entered against you appear in the public records area.

While any of the negative events listed above will remain on your credit report for as long as 10 years, that does not mean that your credit will remain in bad standing the entire time they show on your report. The more time that passes from the recording of the negative payment history, the less weight it gets when calculating your score. No matter what happened in the past, you need to establish a new pattern of paying all your bills on time. Once you begin demonstrating a solid payment history, without any late payments, your score will begin to rise.

Credit Utilization

The next largest component of your credit score is called credit utilization. Credit utilization accounts for about 30% of your credit score. Credit utilization is calculated by examining the size of your debts and comparing it to the total available credit limits you have on your accounts. If all of your accounts are maxed out, you will be considered a poor credit risk, because it appears that you are struggling to pay off the debt you have already incurred. If your account balances are relatively low compared to your available credit, this will help your credit score. While there is no hard and fast rule when it comes to credit utilization, a standard recommendation is for you to keep each of your credit card balances at 30% or less of the card’s credit limit. If you are carrying high balances compared to the credit limit try to pay down your debts as quickly as you can, or even apply for a higher credit limit, but do not use it; let that extended limit lower your credit utilization.

Length of Credit History

Another factor that is used in figuring your credit score is the amount of time your accounts have remained in good standing. Length of positive credit history counts for about 15%. The longer you maintain accounts in good standing, the better your score will be. When you demonstrate an ability to pay on time and sustain a long-term commitment to a creditor, your score will rise. It is natural for you, if you have worked your way out of debt, to never want to be in debt again. This can lead you to close all your accounts and thereby eliminate your ability to incur debt again. If you do so, you will never build a good credit score. Don’t close old accounts that have remained in good standing. You can choose not to run up debt on a particular card, but you want to use it periodically and pay it off responsibly.

Mixture of Accounts

The variety of accounts that appear on your credit report make up about 10% of your score. In order to boost your score, you should aim to have several different types of credit, such a credit cards, consumer loans, and secured debt (such as a mortgage or car payment). This will have a positive influence on your credit score.

Further down the line are other variables like how long you have lived at one address and how many recent hard inquiries to your credit report there have been. The theory is that if you appear stable and are not looking for new credit, then the likelihood of defaulting or getting into more debt is lower.

Positive Steps to Improve Your Credit Score

Now you understand the key factors that make up your credit rating. The next step is to act on this information. Remember that boosting your credit score is a process. It takes time. All of the accurate negative entries on your credit report will appear there for years, so you need to initiate and maintain proper spending and debt management habits.

Start by paying down debts, lowering your credit utilization, and by establishing a positive payment history. Aim to keep all accounts at less than 30% of the credit limit.

Develop a payment pattern that shows lenders that you take your debts seriously. This is something any prospective lender wants from you. Never miss a payment. Sometimes, even when you have the money available, you can forget to make a payment on time. Consider using an online bill paying service, in order to avoid late payments.

Work to establish a mixture of accounts. Your options for opening new accounts will be limited, if your credit rating is poor. If you cannot get traditional loans, like an auto loan, student loan, or mortgage, you can try to obtain a credit card. Gas cards often will have more liberal qualifying rules.

Secured Credit Card

If no credit card issuer will approve you for an account, apply for a secured credit card. A secured credit card requires you to make an initial deposit into an account that the card issuer holds as security. For example, you deposit $500 into an account and the issuer approves you for a card with a $500 credit limit. The security deposit is not what is used to make the monthly payments. Make sure to make monthly payments on the debts you charge on your secured card. These payments will appear on your credit report and start building a positive history. A secured card is expensive, but will help you establish that key variable of a good payment history. As your score rises, you will start to qualify for other types of credit accounts and loans. Using secured credit cards and paying the bills on time is one of the best ways to improve your credit rating.

Minimum of Three Accounts in Good Standing

You want to have at least three active trade lines in good standing on your report. As your credit improves, work to establish a variety of accounts. As you start to demonstrate an ability to pay, the creditors will no longer view you as a high-risk borrower. Don’t be discouraged that creditors will initially approve you for a credit card with a high interest rate. Your goal is to establish credit and use it responsibly. No matter how high the interest rate, if you pay your bill in full each month, you will not subject yourself to the high finance charges.

Your improving credit will further your ability to qualify for additional credit at better interest rates. You will find it easier to qualify for different types of credit, such as auto loans, home mortgages, credit cards, and personal loans.

Summary

Live within your means. Don’t charge purchases just because you want to. Make sure that you can afford to buy something, before you purchase it. Your credit rating is one aspect of your financial life. It does not exist in a vacuum. Consider how your lifestyle affects your credit rating. Establish a monthly budget so you are aware of how much you earn and how you spend your hard-earned money. Establish and maintain good spending and credit habits. Keep working at making payments on time, paying down debts, and building your credit. View your credit report regularly.

Like most anything worthwhile, improving your bad credit takes time. Still, if you follow this strategy, it should not take more than two years, three years maximum, in order to establish an excellent credit score. This strategy is effective for improving your credit score, no matter how low your score is now. Even if you filed for bankruptcy or if you are a person with no credit history, you can improve your credit rating and your general finances in a relatively short time, as long as you are an educated and responsible consumer.

4 Comments
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  • AL
    Americar,
    Oct, 2014
    I really enjoyed this post. You describe this topic very well. I really enjoy reading your blog and I will definitely bookmark it! Keep up the interesting posts!
  • AS
    Alex,
    Anaheim, CA,
    Oct, 2011
    Got capital one credit card they keep requesting that i mail personal info in order to activated.wich i did( twice), tired of getting the run around &want to SUCCESSFULLY close the acct. How do i do this?? Have't used card cuz its not activated. Pls help.
  • JP
    James,
    May, 2011
    Thanks for the tips. Do gas station cards help build a credit score?
    • BA
      Bill,
      May, 2011
      Gas cards should indeed report to the credit bureaus and help you build your score if you pay on time. To make certain, call the card issuer before submitting your application.

      Gas cards usually have a high interest rate, so try to pay the balance in full each month.
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