How Bad Credit Affects You

While working on your credit score may feel challenging, it’s an essential part of building a healthy financial future. After all, having bad credit can make it much harder to qualify for a mortgage, get a loan or even rent an apartment. Even if you do manage to access the credit you need, paying higher interest rates and having to make larger down payments can make it tough to get ahead.

Read on to learn more about what happens if you have a low credit score.

What is a bad credit score?

Think of your credit score as a grade of your ability to manage your finances. Although there are many credit-scoring models, the FICO score is the most popular among lenders. This three-digit number typically ranges from 300 to 850, but a bad FICO score is on the low end of that range, between 300 and 579.

You can monitor your credit score by visiting AnnualCreditReport.com and requesting a free copy of your report from each of the three major credit bureaus: Equifax, Transunion and Experian. Pulling these reports is free and will not negatively impact your credit score.

How your credit score is calculated

Your credit score is based on your financial activity and the items reported on your credit report. When a credit-scoring agency calculates your credit score, they weigh five key factors:

• Payment history (35%): If you have a track record of missing payments or defaulting on loans, this will affect your credit score more than any other variable.
• Amounts owed (30%): This factor looks at how much you owe compared to the credit you have access to, or your credit utilization ratio. The lower the number, the better for your credit score, but experts generally recommend keeping your credit utilization ratio below 30%.
• Length of credit history (15%): This category examines how long your credit accounts have been open (including your oldest account, newest account and the average age of all your accounts). It also considers how long it has been since you’ve used each account.
• New credit accounts (10%): Applications for new credit require hard inquiries on your credit report, which can lower your score. Multiple hard inquiries over a short period of time may signal to lenders that you’re a high-risk consumer.
• Credit mix (10%): While you aren’t required to have one of each type of credit account (mortgage, credit card, installment loans, etc.), maintaining a diverse set of accounts can demonstrate your ability to manage your financial obligations.

How bad credit affects you

If you have a bad credit score, it’s likely that you’ve made some financial mistakes along the way. Lenders can interpret a low score as a sign that you may be a high-risk borrower, while employers and landlords may view you as being less reliable. These perceptions come with considerable disadvantages and can influence nearly every area of your life. Here are some of the ways that bad credit affects you.

Higher interest rates

A low credit score is a red flag to lenders that you may not be able to make your payments on time and in full. To mitigate the risk that you might default on your loan, lenders will charge you higher interest rates to recoup anticipated losses early on. They’re also less likely to extend promotional rates and discounts to you, meaning it will cost you more in the long run to borrow money than it would for your peers with higher credit scores.

Housing

If your credit score is lower than 620, you may have trouble renting a place, as many landlords and property management companies consider this number to be a minimum starting point for tenants. You may be able to rent an apartment even with bad credit, but it could require considerably more effort to make your case, including a higher security deposit or even getting a cosigner.

If you’re looking to buy a home with bad credit, you can expect to pay much higher interest rates. You may also be required to offer a significant down payment of 20% or more. However, you do have some options beyond conventional lenders if you’re a first-time homebuyer, including the government-backed VA and USDA loans, which have no set credit score requirements. You can also look into the Fannie Mae HomeReady and Freddie Mac Home Possible loan programs.

Credit cards

A lower credit score will likely mean that you won’t qualify for the best cards on the market and you’ll have to pay much higher interest rates on your balance each month. You’re also less likely to be offered promotional rates, discounts or perks associated with your credit products.

Owning too many maxed-out credit cards can adversely affect your score, while closing a card completely can also work against you as it will affect your credit utilization rate and possibly your length of credit history. There are credit cards designed for consumers with bad credit, but many of them require you to put down a security deposit.

Auto loans

If you are approved for an auto loan with bad credit, you can expect to pay an upfront deposit, potentially need a cosigner and show proof of a set amount of income. You can also expect higher monthly payments thanks to steeper interest rates. However, once you are able to raise your credit score, you can apply to refinance your auto loan at a much better rate.

Personal loans

Getting a personal loan can be a good tool to help cover emergency expenses or consolidate your existing debts. Getting a personal loan with bad credit isn’t impossible, but it’ll be expensive since personal loans for bad credit come with higher interest rates and fees.

To make the loan terms more beneficial for you, start by looking at your local banks and credit unions. Even with bad credit, local banks may offer loans without upfront fees. Keep in mind that using personal loans to cover regular expenses can be risky. You will want to avoid falling further into debt and hurting your credit score even more.

Insurance

Nearly every insurer will consider your credit score when extending coverage, and a poor credit score can result in insurance rates that are more than double those offered to consumers with good credit. If you have bad credit, insurance companies may perceive you to be at higher risk of making a claim. Poor financial health may be linked to a greater likelihood of irresponsible behavior, which will translate into higher insurance premiums for you.

Employment

As part of a full background check, a potential employer may request access to your credit report. A low credit score could cost you the job, as some employers link it to low trustworthiness or reliability in the workplace, especially if your duties involve handling money. Candidates with a poor financial history could be seen as having a higher likelihood of committing fraud, theft or mismanaging sensitive company information.

Security deposits

If you have bad credit, lenders and landlords may doubt your ability to make payments on time. To protect themselves from financial losses, they may request higher security deposits before allowing you to move in or use their service.

Ways to improve your bad credit score

Even if you have bad credit, the good news is that you can fix it. As you start paying down your debts and building a positive track record of payment history, your credit score will increase over time. Here are some ways you can start improving your bad credit score:

  Pay every bill on time: This includes not just your credit card and loan payments but also bills from utility providers, your cell phone company and other services. Any missed payments could be reported to the credit bureaus and decrease your score; conversely, making payments consistently and on time can increase your credit score. If you find yourself struggling to pay your bills, contact your lender or service provider to discuss other options such as a payment plan or giving you a break on interest fees.

  Pay down existing debts: The more debt you can pay off, the lower your debt-to-income ratio will be, which is weighed heavily when calculating your credit score. Owing less will also save you money in interest fees.

  Avoid new debts: Applying for multiple new sources of credit can be a red flag to lenders. It could signal to them that you are an unstable borrower who cannot manage current financial obligations. New debts can also be an unnecessary temptation and trap you in a vicious cycle.

  Review your credit report and report errors: Request a free copy of your credit report from each of the three major credit bureaus and review it for errors or signs of fraud. Make sure to report them if you do spot any, and take advantage of the credit monitoring and tools that are available to you. You can also check your credit score with LendingTree Spring at any time.

  Consolidate debt: Consider applying for a debt consolidation loan so you can combine all your debts into one monthly payment at a potentially lower rate of interest.