How often do you think about your credit? If you’re like most people, it isn’t very often – until you have to apply for a loan. Then it becomes very important whether your credit is good or bad. Bad credit can be a serious roadblock to funding. So what are the reasons for bad credit? Read on to learn more.
The Problem With Bad Credit
Bad credit indicates that you haven’t borrowed responsibly in the past. One of the reasons for bad credit is that maybe you’ve taken on more debt than you can handle or defaulted on a credit account. Either way, these shortfalls lower your FICO credit score, a three-digit number between 300 and 850.
Anything below 600 is considered to be a bad credit score, but there are no hard and fast rules. Your scores don’t come with a “good” or “bad” credit rating; that’s all at the discretion of the person reading it.
What if I Have Bad Credit?
If your credit is bad, you pose a higher risk to lenders. They might respond by charging you a higher interest rate to compensate for that increased risk. In some cases, the lender might turn you down as a borrower altogether. You might find yourself unable to get a car, a credit card, or even a house.
So how do you get a loan with bad credit? You usually have to fix it.
5 Common Reasons for a Bad Credit Score
Let’s start at the beginning. How can you get bad credit? What are the reasons people have bad credit? There are numerous ways to fall down that rabbit hole, but here are a few of the most common, and how you fix them.
1. Ignoring Bills Until They Go Into Collections
One of the reasons people get a bad credit score is by ignoring their bills. When you can’t pay your bills, it’s tempting to just ignore them. Eventually, or so you think, the credit card company or mortgage company will give up and write off your debt.
Sometimes that is what happens, but it isn’t a good thing. First, when the lender writes off (or “charges off”) your debt, it doesn’t disappear. It becomes a serious black mark on your credit report.
Also, before or after the lender charges off your debt, he or she might send it to a collection agency. That information goes to the credit bureaus as evidence that you don’t pay your bills.
If you have a bill that’s seriously overdue, don’t wait until the creditor gives up! Call them and ask what you have to do to get current. If the bill has gone to collections, find out if the creditor will call the account back so that you can pay them. If not, you’ll have to go through the same process with the collection agent.
2. Prioritizing Collectors Over Current Bills
Another one of the big reasons people have bad credit is by prioritizing the wrong payments. When a bill goes into collections, it’s normal to want to get rid of it. And all things being equal, paying off a collection agency is a smart idea.
What’s not so smart is neglecting your other bills to pay off the account in collections. If you miss other payments while focusing on the collection accounts, you’ll just end up with more defaulted accounts.
Collection agencies are much more persistent than creditors with current bills, but don’t be tempted to over-grease that squeaky wheel.
When you pay your bills, start by paying at least the minimum on your current bills. Then take whatever’s left over and put that toward your account that’s in collections. The debt may endure longer, but you’ll be less likely to have more debts at the end of the process.
3. Applying for Credit Too Often
Applying for credit too often can be one of the big reasons for bad credit. While loans and credit cards can be helpful tools in keeping up with expenses, and those credit card rewards can feel good to get. But there’s a serious downside.
When you apply for a personal loan or credit card, the lender will usually run what’s known as a hard credit inquiry. That lets them check your credit and see if you can afford a loan.
Unfortunately, every time a lender runs a hard inquiry or credit check, the credit bureau takes note. If you rack up too many in a short span of time, your credit score will drop.
If you’ve recently applied for a loan or credit card, try to avoid filling out any more applications for a while. This is especially true if you have a short credit history. Focus instead on cutting expenses and living within your means so you don’t need more credit.
4. Maxing Out Your Credit Cards
Credit is a funny thing – if you don’t use it, you can’t build up a strong credit score. But if you use it too much, it will hurt your credit utilization rate and hurt your score. This is one of the most common reasons for having bad credit.
Your credit utilization is the ratio between your credit card balances and your credit limits. To calculate it, divide your total card balance by your total limit and multiply the result by 100. For example, if you have a balance of $1,000 and a total limit of $5,000, your credit utilization rate is (1,000 / 5,000) * 100, or 20 percent.
Credit utilization ratio counts as 30 percent of your credit score. That means that if you have just that one credit card with a $5,000 limit and you put another thousand on it, your utilization jumps to 40 percent. In other words, it doubles.
Unfortunately, paying off high balances every month won’t make up for running up those balances in the first place. You don’t know if the company will report your utilization before or after you pay. If you can’t keep your credit utilization ratio low consistently, think about opening another card and keeping low balances on both.
5. Going Into Foreclosure or Bankruptcy
As you’re working to manage your credit cards, don’t neglect your mortgage! This is one of the reasons people have bad credit. Any late payment will hurt your credit scores and if you go too far into default, your lender could foreclose. That makes it much harder for you to get approved in the future.
Bankruptcy is even worse. It stays on your credit report for up to 10 years and can bring your score down up to 220 points. That can take you from the good credit score range all the way into the below-600 low credit score zone.
Whenever you feel like you might be sliding into a bankruptcy or foreclosure situation, start getting current with your bills as soon as you can.
If your mortgage is more than you can handle, contact your lender and ask what you can do to get current. If they can’t help, get in touch with a federal housing counselor. You can avoid foreclosure by selling if worse comes to worst.
An Alternative Solution to Bad Credit Loans
No matter what reasons you have for having a bad credit score, there are solutions. Some are better than others. It used to mean that you could lose your home to recover your credit. But not anymore. Now, a sale-leaseback lets homeowners sell but remain in their homes as renters.
Sale-leaseback programs are accessible to many homeowners who don’t qualify for loans. You sell your home but continue to live there, paying rent as a tenant. The application process is easy and doesn’t require you to disclose your credit score or income, just information about your home.
Whatever the reasons for having bad credit, there are ways out. You don’t have to leave your home in order to get your finances under control. Consult a financial advisor to explore your options.