Bad Credit

Bad Credit

What Is Bad Credit?

Bad credit refers to a person’s poor history of paying their bills on time and the likelihood that they will fail to make timely payments in the future. It is often reflected in a low credit score. Companies can also have bad credit based on their payment history and current financial situation. A person (or company) with bad credit will find it difficult to borrow money, especially at competitive interest rates, because they are considered riskier than other borrowers.

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KEY TAKEAWAYS

  • A person is considered to have bad credit if they have a history of not paying their bills on time or owe too much money.
  • Bad credit is often reflected as a low credit score, typically under 580 on a scale of 300 to 850.
  • People with bad credit will find it harder to get a loan or obtain a credit card.

Understanding Bad Credit

Most Americans who have ever borrowed money or signed up for a credit card will have a credit file at one or more of the three major credit bureaus, Equifax, Experian, and TransUnion. The information in those files, including how much money they owe and whether they pay their bills on time, is used to compute their credit score, a number that’s intended as a guide to their creditworthiness. The most common credit score in the United States is the FICO score, named for the Fair Isaac Corporation, which devised it.

A FICO score is made up of five major elements:

  1. 35%—payment history. This is given the greatest weight. It simply indicates whether the person whose FICO score it is paid their bills on time. Missing by just a few days can count, although the more delinquent the payment, the worse it is considered.
  2. 30%—total amount an individual owes. This includes mortgages, credit card balances, car loans, any bills in collections, court judgments, and other debts. What’s especially important here is the person’s credit utilization ratio, which compares how much money they have available to borrow (such as the total limits on their credit cards) to how much they owe at any given time. Having a high credit utilization ratio (say, above 20% or 30%) can be viewed as a danger signal and result in a lower credit score.
  3. 15%—length of a person’s credit history.
  4. 10%—mix of credit types. This can include mortgages, car loans, and credit cards.
  5. 10%—new credit. This includes what someone has recently taken on or applied for.

Examples of Bad Credit

FICO scores range from 300 to 850, and traditionally, borrowers with scores of 579 or lower are considered to have bad credit. According to Experian, about 62% of borrowers with scores at or below 579 are likely to become seriously delinquent on their loans in the future.

Scores between 580 and 669 are labeled as fair. These borrowers are substantially less likely to become seriously delinquent on loans, making them much less risky to lend to than those with bad credit scores. However, even borrowers within this range may face higher interest rates or have trouble securing loans, compared with borrowers who are closer to that top 850 mark.