What is a “Bad” Credit Score and Why is it Hurting You?
Between commercials, regular checks, and everyday conversations, almost everyone is aware of credit scores. Additionally, you often hear about both good and bad credit. For those of you who are not financial professionals, you may ask yourself questions such as:
- What is a credit score?
- What is a bad credit score?
- What are the consequences of my score?
Below, we address each of these questions and tell you everything you need to know about credit score.
Defining Credit Scores
There are a few concepts you must grasp before answering the pivotal question: What is a bad credit score? They include what a score is, who checks for it, and who gives it. A credit score is a three-digit number that is designed to reflect how safe of a lending partner you are. The scale goes from 300-850, with the best scores near the top, and the worst closer to the bottom.
Companies frequently check this score to get an idea of how responsible you are with your finances. Applying for mortgages, car loans, credit cards, and apartment rentals are just a few contexts in which companies use this metric. When you submit your application to that company, they delve into your files and obtain your score.
Now you understand who uses credit scores, but who provides them? The answer is companies called credit bureaus. What these organizations do is compile your financial history into a report and extrapolate a score from it. The top three bureaus in the United States are TransUnion, Experian, and Equifax, but some companies occasionally utilize smaller providers.
What is a “Bad” Score?
Now, you understand what this metric is, but you still might ask “what is a bad credit score?” The answer to this question is slightly different for every lender, but the financial world generally accepts the following ranges.
- Excellent: 700-850
- Good: 680-699
- Okay: 620-679
- Low: 580-619
- Poor: 500-579
- Bad: 300-499
We will explain the specific consequences of low scores later in this article, but being in the low, poor, or bad ranges makes your life harder in a variety of ways. You may not feel the effects day to day, but your score will eventually come back to haunt you if you do not solve your credit issues.
What Affects a Credit Score
Explaining what goes into your score is the next step in answering the question: What is a bad credit score? The following are the five elements that affect your FICO score (the most common type of credit rating), with a percentage delineating each factor’s importance.
- Payment History (35%) – The most crucial factor is your payment history, which mostly keeps track of missed payments. As you can imagine, lenders do not want to give money to people that regularly don’t pay their bills. If you frequently commit this error, your score will suffer.
- Current Debt (30%) – Second, credit bureaus look at your current debt. Even if you pay all of your bills on time, you might only make the minimum payment. If this is the case, your debt will skyrocket. Your payment history will look okay, but anyone that checks your credit will see that you are carrying a significant sum of debt.
- Credit History (15%) – This aspect describes how long you have been paying your credit and loans. If you have never taken out a line of credit or a loan before, your score will be lower than those with more experience. The reason is that people with long credit histories are often more reliable.
- New Credit (10%) – This measures how often you apply for credit. If you are continually opening credit cards and other types of loans, lenders may be wary of you.
- Types of Credit (10%) – Lastly, you get a small bump in your score if you have multiple types of credit. An example is a person who responsibly pays a credit card, car loan, and mortgage all at once. This habit shows lenders that you can handle different kinds of debt, rather than just one.
As you can see, credit scores are not as complicated as they may seem. Instead, they are made up of five relatively straightforward aspects, each of which can be optimized to raise your score
How it Hurts You
You now know the answer to the first pivotal question: What is a bad credit score? Next, let’s discuss how a poor rating can hurt you. The following are the five critical ways in which it can.
- Credit Cards – In the modern world, having a credit card is nearly essential. Not only do you sometimes need one for large purchases, but having one is significantly more convenient than always needing cash on hand. If you have a poor score, your application may get rejected by the top credit card companies. The result will be settling for a card that offers fewer benefits and more restrictions than the best ones on the market.
- Mortgages – Often, credit card companies are willing to take a chance on somebody with bad credit. They will restrict use, raise interest rates, or use some other method that reduces their risk. In the context of a mortgage, the deal is so risky for a lender that they are likely to reject you outright. Even if you are accepted, you will have to deal with high interest rates. This level of interest might not seem like a big deal, but it can cost thousands of dollars over a typical 30-year loan.
- Auto Loans – The same concepts that apply to mortgages also apply to car loans. When you go car shopping with bad credit, you will run into the frustrations of denied applications and high interest rates. Just like with a home, your increased rate could cost you thousands by the end of your loan.
- Apartment Rentals – When you try to rent an apartment, you technically aren’t buying anything. So why do they do credit checks? Although you are renting, the apartment owner still needs to count on you for monthly payments. If you have a history of failing to do so, they have a reason to reject your application in favor of a safer prospect.
- Insurance – One thing most people do not know is that poor credit can even raise your insurance premiums. The reason for this is simple: Bad credit correlates with large insurance claims (source: Texas Business Review). Insurance companies want to give their low-risk customers better deals, so they raise rates on those with bad credit.
- Employment – Roughly 29% of employers do credit checks during the interview process (source: CareerBuilder). The reason for doing so is that, like insurance companies, employers have a higher success rate with those that are financially responsible. Even if you are perfect for a job, they might look into your credit history and decide that they do not want to take the risk associated with poor credit.
If you’ve had negative experiences applying for credit cards, auto loans, mortgages, and apartment rentals, there is a high chance it is because of your credit score. Now that you have educated yourself, you can answer the question we started with: What is a bad credit score and why is it hurting you? Additionally, you can begin your journey towards raising your score. Once you do, you will be on your way to optimizing your financial standing and reaping all of the benefits that come with it.