What is a low credit score?

Bad credit reportA bad credit rating occurs when the debtor (person owing money to a creditor) fails to make the loan payments as agreed or simply walks away from the debt obligation. A low credit score (see below) represents bad credit, while a high credit score is an indicator of good credit.

The interest rate is often higher with individuals with bad credit because lenders face a greater risk that the individual will miss payments or default on the loan.

Late payments, tax liens, accounts in collection, judgments, repossessions, bankruptcies, foreclosures, settlements, and charge offs are considered bad credit and will have a powerful impact on the credit score. If you have one of these items on your credit report or several of them, the odds of having a lower credit score are much higher compared to someone with a clean credit history.

There are five factors that determine a credit score.

Payment History:

The payment history is the single most important component of the credit score (35%). A single late payment can reduce a credit score by 40 to 100 points. Multiple late payments will reduce the credit score even further. The higher the credit score is when the late payment occurs, the greater the impact on the credit scores.

Credit utilization:

The credit score formula is based on the individual's use of credit. 30 percent of the overall credit score is dependent on a borrower's credit utilization. In other words, if the balance on credit cards and other revolving accounts are close to the high credit limit, the credit score will be revised downward. Experts suggest account balances should be at or below 50% of the high credit limit.

Credit history time-span:

15 percent of the total credit score is based on the length of time each credit account has been open and the period of time since the account's most recent action. A longer credit history gives more detail about a borrower's payment reliability and provides a clearer picture of long-term bill paying behavior.

Credit mix and new credit each comprise 10 percent of the total credit score:

Individuals with bad credit should avoid opening credit accounts, because recent credit inquires and new loans can suggest financial trouble.

Credit mix indicates the individual can handle all types of credit. Statistically, borrowers with a good credit mix of revolving credit and installment loans generally represent a lower risk for lenders.

The credit ranking scale is approximately:

Below 600: Bad
600 to 649: Poor
650 to 699: Fair
700 to 749: Good
750 or higher: Excellent

How to improve bad credit

credit repair1. Request a free copy of your credit report and check it for errors. Your credit report contains the data used to calculate your score and it may contain errors. In particular, check to make sure that there are no late payments incorrectly listed for any of your accounts and that the amounts owed for each of your open accounts is correct. If you find errors on any of your reports, dispute them with the credit bureau. Go to the Federal Trade Commission and obtain your free credit report from Equifax, Experian and TransUnion. 

2. Since payment history has the greatest impact on a credit score, it’s important to pay your bills on time. Late and delinquent payments will have a major negative impact on the credit score. Missed payments should be paid current and stay current. The credit score will increase the longer you pay your bills on time after being late. Past credit problems fades as time passes as recent good payment patterns show up on the credit report.

Pay off collection accounts. It should be noted that the paid off collection accounts will stay on the report for seven years.

Amounts Owed Tips

3. Try to keep credit balances as low as possible on credit cards and other "revolving credit". High outstanding debt will affect a credit score. Avoid moving debt around. Try to pay off the outstanding balance or reduce the balance by one half. Do not close unused credit cards. Closing active credit accounts can actually hurt your credit score and don't open new credit cards that are not needed.

Length matters

4. New credit accounts will lower the average account age, which impacts the FICO scores. Rapid credit buildup can appear risky to lenders. Don't open a lot of new accounts too rapidly.

Types of Credit Use Tips

5. Only apply for and open new credit accounts only as needed.

Don't open credit accounts just to have a better credit mix, chances are, it probably won't increase your credit score.

It’s ok to have credit cards, but manage them responsibly.

To summarize, "fixing" a credit score is more about fixing errors in your credit history (if they exist) and then following the guidelines above to maintain consistent, good credit history. Raising your scores after a poor mark on your report or building credit for the first time will take patience and discipline.