Bad Credit: What Is It? How Does It Affect You? How Do You Rebuild Your Credit History?

You might know that your credit report (which includes your credit score and credit history) determines which loans you qualify for and at what interest rate. But, did you know that bad credit can affect more than your ability to borrow?

Today, we’ll explore how far-reaching your credit report really is, its impact on your everyday life, and how you can raise your score by building non-existent credit and rebuilding bad credit history.

Before we dive in, we first need to know what bad credit is. After all, you can’t fix what you don’t know needs fixing, right?

Defining bad credit

So, what is bad credit really?

Simply put, your credit is a reflection of your ability or inability to pay back money you borrowed. It’s a measure of your credit worthiness.

Bad credit reflects past failures to pay back money, like bankruptcy or loans that went to collections. This can also include loans that are paid off, but not in a timely manner as agreed upon with the lender.

For example, let’s say you had a personal loan that was due on the 14th of every month. However, you regularly came short so you occasionally made your payments late.

Even though the debt appears to be paid off in full on your credit report, the late payments can lower your credit score and taint your credit history, deeming you unworthy of certain loans.

How your credit score is calculated

There are three major credit bureaus –Equifax, Experian, and TransUnion– that collect and store your credit information. Also, there are two main credit scoring companies –Fair Isaac Corp (or FICO) and VantageScore Solutions– that use this information to generate your credit score.

What is your credit score? Your credit score is an accumulated numerical value of your credit worthiness compared to others generated, based on the information from your credit report.how credit score is calculated

For instance, FICO uses numerical values ranging from 300-850. They consider your credit history, current loans, credit card debts, and your length of credit history to generate this score.

Take a look at the graph to see how your different credit information is used to calculate your score.

Generally, the lower the score, the worse your credit is and the more risk you are to lenders. Likewise, the higher the score, the more likely you are to pay back money you borrowed.

Who determines if you have worthy credit?

Although FICO and VantageScore use your credit report to calculate your credit score, they don’t actually determine if your credit score is good enough for receiving certain loans. The lender decides that.

For example, let’s say I want to get a credit card and I apply for it. The company I applied with will pull my credit report and decide, based on their standards and my credit information, if they want to approve me or not.

3 negative effects of bad credit

More recently, other industries have started checking credit history to see if a person is fit to do business with.  This is a big deal and makes your credit even more important. If you have bad credit, you’ll feel the effects in more ways than one, trickling down to your day to day life.

Here are 3 negative effects of bad credit that go beyond borrowing and interest rates:

1. Higher Insurance Rates

Insurance companies consider your credit history in determining your coverage rate. Why? Your credit reflects how responsible you are.

“Many U.S. car insurance companies use credit-based insurance scores to help determine risk. (Unless you live in Massachusetts, Hawaii, or California, where the practice has been banned.) And studies have shown that there’s good reason to use credit-based scoring in developing rates.”

Esurance

If you are careless with your financial obligations, who’s to say you’re not the same way behind the wheel? To them, a bad credit score equals irresponsible. And they have the studies to back it up.

Here is an independent study done by the Federal Trade Commission to better understand the relationship between bad credit and risk.

Also, check out this analysis-based study of 175,647 policies by The University of Texas. It reveals that lower credit scores incur more car insurance loss and higher claims.

2. Utility Companies 

“Having bad credit will affect how reliable utility companies perceive you to be, as a shaky payment history could make you look like a liability.”

Natasha Rachel Smith, Personal Finance Expert at TopCashBack.com on Opploans.

It only makes sense that a utility company would pull your credit to determine if you can open an account. Firstly, some of the equipment used can reach upwards of hundreds of dollars. If you show patterns of poor financial choices, it could be risky for the company to approve you.

Secondly, utilities are billed like credit– consume first and pay later. With that method, you can rack up a bill. Any good business will make sure you’re able to pay for a product or service before they give it to you. And the easiest and surest way for them to know is by pulling your credit report.

3. Potential Employers 

Are you looking for a job or pursuing a promotion? More and more employers are pulling credit history as part of their background check, so you might need a good credit to succeed in your pursuit.

“Many companies check job applicants’ credit as part of the background check. Some also check credit histories when employees are considered for promotions, so you can’t assume that because you have a job at the company, your personal information is going to remain personal.” -Dona DeZube, Monster Finance Careers Expert.

The reason? Your credit measures more than your financial dealings; it reveals your character. Careless financial habits and poor financial choices from the past can put a ceiling on your career.

The 2010 Society for Human Resource Management report found that while almost 6 in 10 organizations pull credit reports on some candidates, only 13% check them all, according to CreditCard.com (unless you live and work in California, Colorado, Connecticut, Delaware, District of Columbia (D.C.), Hawaii, Illinois, Maryland, Nevada, Oregon, Vermont, and Washington, where this practice is banned).

Bottom line: bad credit can hurt your job hunt.

How to fix bad credit history and increase your credit score

Good credit gives you options. Bad credit puts you at a disadvantage and can affect your day-to-day living . The good news is, even if you have a horrible credit score, you can fix it.

Here are some basic steps you can take today to rebuild your credit history and increase your credit score:

1. Check your credit status

The first thing you need to do when it comes to fixing your credit is to identify the problem. Knowing the condition of your credit will help you know what steps you need to take to rebuild your credit faster.

You can go a couple of different ways to track down your credit information. I personally like using Credit Karma. It notifies me when someone pulls my credit report (and what company it is) and when my score fluctuates. And it’s completely free.

If you prefer, you can also access your credit information via the three credit bureaus. You’re allowed one free report from each of them per year. Go here to request your credit report.

2. Get your accounts up to date

Your payment history plays a big role on your credit score. In addition, having updated payments makes your credit report look more eye-catching.Credit

“The first thing any lender wants to know is something about your credit history. Namely, whether your credit payments have been made on time.” -MyFICO.com

If you have bad credit, make it a priority to get your accounts up to date. It’ll not only increase your score, but it can be the start of responsible on-time payments.

3. Lower your credit utilization

Credit utilization is the percentage of credit you’ve used that is available to you in a given billing cycle. For example, if you have a balance of $100 and your credit limit is $500, your credit utilization is 20%.

It’s important to have a lower utilization because the less you use, the easier it is to pay it off. Remember, your credit score is the measure of your likelihood of paying back.

Pay down some of your debt to bring down your credit utilization.

“Generally, a good credit utilization ratio less than 30%. To achieve 30% credit utilization, that means keeping your balances below 30% of the credit limit. Anything above 30% can hurt your credit score. On a credit card with a $1,000 limit, that means keeping your balance below $300.” -The Balance

4. Maintain and keep old accounts open

Your credit score takes into account the age of your account. In FICO’s measuring method, the length you have an account open accounts for 15% of your overall score. If you’re sitting on the border, that could be enough points to bump a bad credit score to an average credit score.

Have you experienced any negative effects of having bad credit? What have you done, or what are you doing to rebuild your credit report and increase your credit score?

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Francis John

I used to be careless, uncommitted, and inconsistent in my financial obligations. One day, things changed. Today, I am in control of my finances. I want to show you how.

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