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Bad Credit

Posted by: Staff Writer | May 22,2008

Everything You Need to Know about Bad Credit

Here’s everything you need to know about bad credit but were afraid to ask.  If you are afraid, this is not much of a surprise because bad credit can affect every avenue of your life: buying a home, a car, getting a new credit card, even getting a job.  Cleaning up your credit rating is key to your financial future. 

What is Bad Credit?

First, though.  What exactly is bad credit?  Excellent credit is a Fico score of 720 and above.  It’s been estimated that most people have a median credit of 600 to 800.  Anything below 600 and you should be looking at a pretty aggressive credit repair plan.  Lenders use your credit rating to determine the interest rate on a loan, meaning if you have a low credit limit, you’ll be faced with higher interest for any type of loan.

How You Get Bad Credit

The basic ways that you obtain bad credit are as follows:

1.    Not paying loans on time – the larger the default, the lower your score will go.  Defaulting on a mortgage can have the biggest impact on a credit rating.  
2.    Having a credit card balance that is more than 40% of the limit.
3.    A short credit history.  If you’ve got a short credit history with a lot of problems, your credit rating is going to suffer for it.  
4.    A large number of recently opened accounts.  Opening up five credit card accounts in a few-month span will affect your rating.

The worst offenders of bad credit are:

1.    Charge offs: not paying a bill off for six months or more.  These are listed on the report as a “charge off” and will remain on your credit report for seven years.  
2.    Collections: Whenever a creditor tries to collect on an outdated debt.
3.    Bankruptcies: A bankruptcy will remain on a credit report for seven to ten years.  
4.    Foreclosures: Losing a home due to defaulting mortgage payments.
5.    Tax Liens: Not paying property taxes can also severely affect credit rating.  
6.    Lawsuits: In extreme cases of all of the above, the problem may be settled in court.  This will be listed on your credit report. 

Scouring a Credit Report

To make sure you have none of the above on your credit report, you need to order up a free credit report.  Contrary to some misconception, getting a credit report does not have an adverse impact on your credit rating.  While getting more than one a year can affect your rating, you are entitled to one free credit report a year.  These can be found via the three major credit reporting agencies: Experian, TransUnion, and Equifax.  

You must go over your credit report with a fine tooth comb.  Note: there are mistakes on your credit report that can lead to bad credit.  Erase these mistakes as soon as possible.  Check to see all relevant information is in order:

1.    Your name/address/Social Security Number
2.    All past accounts, including all past loans.  There may be a canceled account still remaining on the report.  
3.    All information pertaining to the “How You Get Bad Credit Section.”  Make sure all information is up-to-date and accurate.  

If it is not accurate, you need to contact both the credit bureau and the creditor.  Mail the credit report to both agencies with the error circled, in addition to a letter stating the problem. 

How to Clean Up Bad Credit

If you have a FICO score of 600 or below, you need to enact a credit-repair plan.  First, identify where your greatest credit problems are centered.  Credit repair is not going to happen overnight, as it can take up to seven years to fully clean up a credit report, so you need to begin immediately.  The surest way to clean up a credit report is to reverse your past habits.  Simply:

1.    Pay your bills on time.  
2.    Pay your credit card bills above the minimum to get the balance under 40% of the limit.  

Next open up new accounts, but heed the advice above: do not open too many accounts at once.  Opening up a new credit card account will establish a new history.  If you keep the account healthy, you will help raise your rating.  Charge items and then pay them off in full every month.  Checking your debt-to-income ratio is also very important: the amount you have coming in vs. the amount going out every month.  Effective budgeting is vital for credit repair.    

If you’ve already got 4 credit cards outstanding, you have to work on getting those outstanding balances under control.  Be sure to make the biggest payments for high-interest cards first so you’ll get out from under the weight of that card sooner.  Transferring part or all of a high-interest balance to a card with an attractive balance transfer plan is also a sound idea. 

Other Credit Repair Options

The main way to repair credit is to get your debts under control.  If you’ve got less of a debt burden every month, you won’t be as likely to default on those loans and you’ll be debt-free sooner rather than later.  

Debt Consolidation: This combines several outstanding debts into one payment.  Normally this is managed through a home equity debt consolidation loan, though this can be achieved through other methods, such as combining several outstanding student loans into one payment.  Keep in mind that any credit card in a consolidation plan will be frozen so it can not be accessed further.  

Debt Settlement: A debt settlement provider will attempt to renegotiate your debt for less than it would be over the long term.  The result is that you have to pay the renegotiated debt amount in full, so this is not always an option for those who are financially taxed.  Important: have the debt settled as “paid,” and not “settled for less,” or it will further damage your credit.  

Credit Counseling is similar to debt settlement, except that the debt doesn’t necessarily need to be paid in full.  The counselor instead negotiates for a lower payment.  Be aware that the creditor must recognize the new payment or else it may appear that you’re paying under the minimum every month, damaging your credit.  Credit counselors also act as financial advisors who work with you to help budget effectively and create a long-term debt payment solution.

What Bad Credit Means to Your Financial Future

Basically, bad credit can affect every avenue of your life.  If you apply for a mortgage or a car financing plan, you’ll be stuck with high interest rates if your credit is 600 or below.  There are a number of bad credit offers available: bad credit mortgages, credit cards for bad credit borrowers, etc. but these will have a high rate and potentially high fees.  Even employers are checking a credit rating more often.  If a credit report shows a bankruptcy or other problem this is a bad reflection on the person seeking employment.  

Bad credit shows that you have had problems meeting the demands of a loan in the past.  Lenders will be wary about offering a new loan and so raise interest rates as a way to protect themselves against future default. 

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