A job layoff or period of illness can easily leave a person with a bad credit score. Many people aren’t sure what is considered a bad credit score or what steps to take to raise it into the good range. It can’t be done overnight but the good news is that any credit score can be turned into a good one with patience and hard work. Start by understanding what elements make up a credit score and how to address each to improve a bad credit score.
There are several credit scoring systems but the one that is familiar to most people is the FICO score (short for Fair, Isaacs, & Co., the company that markets the scoring system). The FICO system is used by all of the “Big Three” credit reporting agencies (Equifax, Experian, and TransUnion) and is the virtually the standard system in the United States. The scoring range is from 300 to 850 (a perfect score). Although you are not able to get your credit score for free once a year like you can your credit history, you can obtain it for a small fee from these companies.
What is considered a bad credit score depends on the type of credit you want and the lender. For home mortgages, major lenders such as Freddie Mac and Fannie Mae use a two step ranking. A score of 640 is best, but 620 is acceptable, although the interest rate on the mortgage will be higher. Anything below 620 is considered “sub prime.” The Federal Housing Authority (FHA) insures home loans for people with limited incomes or had credit problems in the past. At one time the FHA did not use the FICO score, but adopted a standard of 580 in 2008 as part of an update of their credit evaluation procedures (check the FHA website for details of the changes).
For other types of credit like car loans and credit cards a FICO score under 620 is considered bad, or at least sub prime. Not all lenders will loan money to those with low credit scores. That doesn’t rule out getting credit. In fact, it’s always possible to get some sort of credit. When lenders consider lending to someone with a bad credit score, they look carefully at the person’s credit history and asses the risk of loaning them money. Interest rates will reflect this, so the lower the score, the higher the interest rates. In extreme cases, a person can get a secured credit card (one where they put enough money down to guarantee the lender will get their money). These are very high interest rate cards, but provide individuals with a place to start rebuilding credit by demonstrating they will make regular payments.
Preventing (or improving) a bad credit score depends on building a credit profile that satisfies the criteria used to calculate the FICO score. Number one on the list is to make payments on time. You should be especially vigilant about not allowing any payment to be 30 or more days late. The amount and type of dept you owe is also important. If you are already overburdened with debt, no lender is going to want to lend you more. Unsecured, high interest debt like credit cards is harmful if you owe too much of it. Start reducing your debt by paying down high interest credit cards. You can also improve your credit score by asking lenders to lower credit card limits as you pay them off. This helps because you have less credit at your fingertips you might use. Finally, avoid applying for new credit accounts or closing old ones frequently. Doing this occasionally is appropriate, but lenders see constantly opening or closing accounts as an indication of poor financial management.
There are some specific do’s and don’ts to preventing a bad credit score. Don’t default on a student loan (this will never come off your credit history). Avoid a foreclosure or tax liens if at all possible. Don’t ignore collection efforts. If a creditor takes you to court it will seriously damage your credit. Do consider a debt consolidation loan. It’s a god way to lower your monthly payments and possibly interest rates as well. Finally, if you run into trouble, the first thing you should do is talk to your creditors. Most will work with you and even make special payment arrangements. Furthermore, many won’t report this to the credit reporting companies if you show good faith by fulfilling any agreements you make.