Key Takeaway

Repaying debt can be burdensome at times due to unforeseen or inevitable circumstances. You must make regular debt repayments to avoid your credit score taking a hit. Debt is an essential tool for creditors to assess an individual’s creditworthiness, but you must aim to maintain it in good standing. Let’s understand what bad credit is, what it can mean to you as a debt borrower, and what to do if you already have a poor credit score.

In financial terms, bad credit indicates a low credit score and a less than perfect credit history. It indicates that you have failed to make the monthly repayments of your debts or have multiple late payments.

Individuals with bad credit find it difficult to borrow from credit unions or financial institutions. Even if they manage to do so, the offered interest rates can be significantly higher than usual. This applies to both secured debts and unsecured debts.

How bad credit affects your ability to borrow

If you have ever borrowed money or owned a credit card, you already have a credit report with a credit bureau.

The top three credit bureaus in the country are Experian, Transunion, and Equifax. These credit bureaus keep track of how much money you owe in debt and your repayment history, which helps them generate your credit score.

The FICO score is the most common credit score in American financial institutions

 It is calculated based on five factors:

  1. Timely payment history of bills (35% weightage)
  2. The total debt on an individual (mainly credit utilization ratio) (30%)
  3. Length of credit history (15%)
  4. New credit accounts (10%)
  5. Types of credit used (10%)

The most crucial factor that affects your credit score is your debt repayment history. So always ensure to pay your bills on time.

Different lenders have different credit score requirements, but here are a few critical drawbacks of a bad credit score:

  • Difficulties in prequalification for loans and line of credit. Most creditors will just discard applications with a bad credit score.
  • High-interest rates on debts
  • High premiums on insurance
  • Paying a deposit for utilities
  • Hiring problems for some roles
  • Fewer renting options
  • Not being able to buy a home 
  • Not able to buy a car 

You can get a free credit report annually from each of the major credit bureaus to check your credit score and find ways to improve your credit profile.

Examples of bad credit scores

Your credit score (we’ll take the example of FICO here) can range between 300 and 850. Here are a few examples of credit scores to help you understand the concept in detail:

300 - 579 (Poor)

A FICO score between these ranges is considered poor and signifies that the borrower cannot handle debt. It impacts your eligibility for any type of loan unless you have a co-signer for your application process or it is for a credit-builder debt scheme (like some specific credit card offers).

580 - 669 (Fair)

With fair credit scores, you have a 50-50 chance of loan approval. It shows that you are having difficulties with debt repayment, that you have missed a few payments, or that you have entirely maxed out all of your credit cards. You may be eligible for subprime loans, but those are typically available at a higher interest rate.

670 - 739 (Good)

The national average credit score is 714 points. Finding a loan with scores in this range is easy, but you may have to settle for high-interest rates.

740 - 799 (Very Good)

A healthy credit score range signifies that you are eligible to apply for almost all secured and unsecured loan offers with lower interest rates and better loan terms.

800 - 850 (Exceptional)

The perfect credit score, granting you access to the best credit cards and loan options that lenders have to offer, including the most exceptional annual percentage rates.

How to fix a bad credit score

Fixing a bad credit score may take some time and effort. Here’s what you can do about it:

Set Up Automatic Payments

If you have a debt, pay via the online automatic payments method (autopay) rather than tracking it yourself.

The monthly payments for your debt will automatically be deducted from your bank account at the end of the billing cycle.

It will ensure that you pay every month and never skip a payment. On-time payments can have a measurable impact on your credit score.

Keep Old Credit Card Accounts Open

If you have any unused credit card accounts which are currently active, keep them open. It helps you maintain a good credit utilization ratio. Closing accounts might sound like the right things to do, but it actually hurts your credit score.

Don’t apply for any new credit cards unless you need them.

Pay off Debts

Try to pay off your debts as soon as possible. Focus on paying the debts with the highest interest rates first, typically credit card debt, and then move on to smaller debts.

Check the interest rates disclosures to keep track of the interest rates of all your loans and credit cards. This will free up your available credit and improve your credit utilization ratio.

Avoid New Debt Inquiries

Do not apply for new debts if you struggle with a low credit score.

Credit checks done by financial institutions and credit card issuers will affect your credit history, appear on your credit reports, and may signal lenders that you are taking new debts to repay existing ones.

Always ask if someone is doing a "Hard" pull or "Soft pull of your credit. Since soft inquiries aren’t connected to a specific application for new credit, they will not ding your credit score. On the other hand, when a financial organization, such as a lender or credit card issuer, investigates your credit when making a lending decision, this is referred to as a hard inquiry. They frequently occur when you apply for a mortgage, loan, or credit card, and you are usually required to authorize them as they will affect your credit.

Pro Tip: Avoid companies claiming ‘quick fixes’ to your credit score. Credit repair cannot be done overnight.

How to pay off debts and improve a bad credit score

Take a look at these tips to pay off debts and build your credit effectively:

  • Compare interest rates from different creditors and look for low-interest rates on an appropriate term. Avoid higher interest rates as much as possible.
  • Never take more than you can afford to pay. Make a plan before you take on debt based on your current financial situation and prospects. Think twice before you max out your credit limit. 
  • Pay more than the minimum amount and try to pay off debts quickly. Focus on your most expensive debt first, usually unsecured debts like credit cards or personal loans.
  • Consider debt consolidation to transfer all your current debts into a single debt with a low-interest rate. It can be a personal loan, a balance transfer credit card, or a debt consolidation plan from a financial institution.

If you already have debts and bad credit, or if your utilization rate is 100% or more, meaning maxed out, this impacts your credit score more than you know. If any of this applies to you, you may not be credit worthy any longer, and it may be time to look for a debt relief program.

There are debt relief companies that can help you pay off your debts faster through strategies that fit your financial needs. They can also guide you on building credit and staying on track once you are debt-free.