What Exactly Is a Bad Credit Score?—A credit score is a one-of-a-kind credit rating system that informs lenders about the risk associated with lending to an individual. It was developed by the Fair Isaac Corporation (FIRC), an American data and analytics organization, to assist consumers in determining their credit status and lenders in making timely and informed lending decisions. Your credit score is calculated using the information contained in your credit report, which is a snapshot of your credit history over time.
Credit score elements influence the credit score, and the lower the credit score, the riskier the borrower is to lenders. A credit score is a three-digit figure that ranges from 300 to 850. The following are the standard measures used to calculate the credit score:
- Very Good 750-799
- Good 700-749
- Fair 650-699
- Poor 600-649
- Very Bad 300-599
What Is Bad Credit?
Bad credit refers to a person’s history of failing to pay debts on time, and the likelihood that they would fail to make timely payments in the future. It is often reflected in a low credit score. Companies might also have bad credit depending on their payment history and present financial status.
A person (or corporation) with negative credit will find it difficult to borrow money, especially at competitive interest rates, because they are deemed riskier than other borrowers.
Any individual who has taken out a loan or applied for a credit card will have an active credit file with one or more of the three credit agencies. The credit report contains information about a person’s credit activities and events over the last several years, such as loan applications, the number of loans approved/rejected, credit card approvals/rejections, credit card loans, and foreclosures. Lenders and creditors have access to all of this information, which they use to make loan choices.
Lenders use the credit report to create the credit score, which is a numerical value that indicates the risk involved with lending money to particular borrowers. Lenders evaluate an individual’s credit score to determine whether or not to offer credit, the amount of loan they would provide, and the interest rate. Landlords utilize an individual’s credit report and credit score to assess whether or not to rent them an apartment based on their credit history and financial status.
Five Major Reasons for Bad Credit
Bad credit is caused by a number of critical reasons, which are described below:
1. Delinquent payments
Payment history accounts for 35% of a person’s credit score. If you have gone more than a month without making a payment, the creditor may have submitted the information to the credit bureaus. Additionally, the data is recorded on your credit report.
If you repeatedly miss payments to lenders, credit card companies, or utility suppliers, your credit score will suffer. If you do not improve your bad credit, it may result in your credit score being labeled as “poor” or “very poor,” which may reduce your chances of being approved for a loan.
2. Accounts for collection
When creditors are unable to collect from a borrower, they can enlist the assistance of third parties to complete the collection process. Before or after charging off their account, the majority of creditors hire or sell delinquent debt to debt collection companies.
When accounts become late and are sent to collections, the information is recorded on the credit report. Unless and until such information is corrected, creditors will find it difficult to extend credit to a borrower with a history of bad collection.
3. Initiation of a bankruptcy
If an individual or business is unable to repay obligations, they may be obliged to file for bankruptcy. Bankruptcy is a drastic event that has the greatest negative impact on an entity’s credit score.
If a borrower declares bankruptcy, the information is recorded on the borrower’s credit report for seven years. Due to the intricacy of bankruptcy cases, most lenders are hesitant to lend to borrowers who have a history of bankruptcies and court proceedings involving their financial condition.
If an account has been late for an extended period of time, the creditor may charge it off. A charge-off indicates that the creditor has given up on attempting to collect payments from the borrower, and it creates a black record on the borrower’s credit report. When an account gets charged off, the account holder loses the ability to use the account to make purchases. When a charge-off happens, the borrower continues to owe the creditor the charge-off balance.
Unpaid charge-offs will result in a decrease in credit score. Once a charge is made against an account, the information is reported to the credit bureaus. Charge-off information is reported to credit bureaus for seven years from the date the account became delinquent.
5. Loan defaults
Loan defaults are handled similarly to account charge-offs. If you miss more than one payment and do not make up the difference by the end of the month, the account is designated as delinquent.
The lender will report the information to credit bureaus, resulting in a negative impact on the borrower’s credit reputation. When prospective lenders examine the data, they will view the borrower as a high-risk credit risk who is extremely unlikely to repay loans.
How to Determine Your Credit Score
The following factors contribute to the computation of your credit score:
1. Payment History: This refers to the extent to which payment terms have been adhered to. It should ideally be around 35%, however factors like as bankruptcies, late payments, and non-payment impact the outcome.
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2. Amount Owed: This factor considers the balance on your account, the number of accounts with a balance, and available credit. This rate exceeds 30%.
3. The Pursuit of New Credit: If you have just opened a new credit account, your credit score will be compared to your credit history as a whole. The rate exceeds 10%.
4. Credit History Length: You can have a good credit score with a short credit history provided the rest of your report demonstrates your credit responsibility. A longer credit history, on the other hand, improves your credit score. The rate exceeds 15%.
5. Credit Mix: Installment loans, credit cards, and personal lines of credit all have the potential to boost your credit score modestly. The rate exceeds 10%.
How do you obtain your credit score?
Credit score is critical to one’s financial well-being. It is a three-digit summary of your credit report that identifies your creditworthiness by summarizing your credit actions throughout the course of your borrowing history.
If you’ve ever contemplated applying for a loan, your credit score is what lenders use to decide if you’re a safe or risky consumer. Your credit score is determined by the activity of your accounts.
To obtain your credit score, you must first obtain your credit report, as your scores are based on the information contained in your reports. A credit report contains information about your previous and current credit agreements. These include credit, loans, mortgages, debt collections, cards, whether you’ve made on-time payments on your bills, and the list of firms that have viewed your credit history in the most recent period. These credit checks are referred to as enquiries.