“Do I have bad credit?” The answer to this question can determine whether or not you will be approved for mortgages, auto loans or credit cards. It will also determine how much you will have to pay for those products if you are approved.
Different Types of Credit Scores
The traditional measure of your credit worthiness is a credit score. And the original credit score was FICO. This score is still used in nearly 90% of all lending decisions, and is particularly important in the mortgage market. It is fairly easy to get your FICO score for free. We tell you where you can find a free FICO score here.
FICO measures how successfully you have managed consumer debt in the past. The most important factor in the score is on-time payment history. The score also looks at how much debt you have (the less debt and the lower utilization the better) and how long you’ve had credit. In addition to missed payments, negative items like collections, judgements and foreclosures can have a big impact on your score. Based upon your behavior, you will receive a score between 300 – 850.
The three credit bureaus, tired of FICO’s monopoly, created VantageScore. It looks at many of the same attributes, and it uses the same scale. That is why it is often referred to as the FAKO. Most of the free credit score websites provide you with a VantageScore.
The scale on FICO and VantageScore is similar. You can see what those scores mean here:
- Above 750: Excellent Credit
- 680 – 749: Good Credit
- 620 – 679: “Near Prime” or Acceptable Credit
- 550 – 619: Sub-prime
- Below 550: Bad Credit
With Excellent or Good credit, you will likely be approved for almost any credit product. Near-prime customers are seeing more options every day, as banks and finance companies expand their product offerings. Sub-prime borrowers will have fewer options available, and they will all be very expensive.
People with Bad Credit have a score below 550. If your score is this low, it will be very difficult to obtain any financial product. Your focus should be on improving your score, which we explain in our Debt Guide.
There is no difference between having no score and having a bad score. If you have no credit history, you should start building it with a secured credit card.
Is My Credit Score Enough?
Your credit score is a good indication of whether or not you will be approved, but it is not enough.
Credit card decisions are largely automated and score-driven. However, in addition to your credit score your debt burden is extremely important. Your credit score does not know how much money you make. $20,000 of debt can be a lot (if you make $40,000 a year), or not much at all (if you make $500,000 a year). Your debt burden looks at your monthly expenditure and compares it to your monthly income. Usually, only expenditures reported are the credit bureau are included. That means things like your mortgage, car payment, credit card payments and any other form of unsecured debt. If your debt burden is above 50%, you are typically considered a bad credit risk and would be declined by most lenders. Excellent Credit means a debt burden below 30%. And there are debates about everything in between.
In addition, most banks will look at how rapidly you have been building up debt. If you have been accumulating a lot of debt recently, the bank will likely consider you a high risk, and you will have fewer opportunities to borrow at a good interest rate.
For products like mortgages and auto loans, your down payment and income are also extremely important when the bank considers your level of risk. The lower the down payment, the higher the risk.
Especially for mortgages, you will probably have your income and employment verified. Banks like people with steady jobs and a long history of employment. If you have highly volatile income, you are considered riskier and may be rejected. Or, the bank may not consider all of your income, given its volatility.
So, What Is Bad Credit, Really?
When people talk about their “credit,” they are really talking about their likelihood of being accepted. To have bad credit means that you have a low chance of being approved. And here are the main reasons you find it impossible to get any form of credit approved:
- Your score is below 550
- Your debt burden is above 50%
- You have no credit score
- You have been building up a lot of debt recently
- You are unemployed
The only way to improve your debt burden is to pay down your debt or increase your earnings. If you are starting from no credit score, you can build a good one very quickly. Improving a damaged score takes more time, but it can be done. In a worst case scenario, every negative item will disappear from your credit score in seven years. But most people, with focus, can have a dramatically better score in 12 to 18 months.
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