In a perfect situation, everyone would have great credit. You would have the right mix of accounts, the perfect amount of debt maintained, and all of your payments made on time.
But not everyone has great credit. Some people have bad credit, and some people have no credit at all. These things can happen due to marriage, divorce, or simply being young. So if you’re trying to make a purchase, get a credit card, or get a home loan with bad credit, how do you manage bad or no credit? Is one worse than the other? Let’s look at the ins and outs of less than stellar credit.
What’s the difference?
When you’re trying to rent an apartment or buy a car, having no credit and bad credit can feel exactly the same – it can still be hard to get the funds or trust you need to move forward. But having bad credit or no credit come from two different situations, cause two different problems, and have two different fixes.
No credit means simply that you don’t have any credit history. You probably haven’t rented an apartment on your own, had a credit card, or had a loan in your name. This can be a common situation for someone who has been married if their spouse had all the bills and cards in their name. It can also be common for younger people who haven’t lived on their own yet.
Bad credit, meanwhile, means that you’ve had credit cards and bills where you’ve overextended your credit, made late payments, or possibly even defaulted on a loan and had something repossessed or sent to collections. You may also have needed to declare bankruptcy at some point.
Downsides of bad credit
When potential lenders (and that includes landlords) look at your credit and see that it’s bad (generally defined as below 630 on a 0 to 850 scale), they will have some reservations about loaning you money. From where they sit, they think of you as a bad investment.
No one loans out money or property for free; they are looking to get a return on their investment through your monthly payments. For a bank or credit card company, that return comes in the form of monthly interest. For a landlord, that return is the price they charge for your rent that is more than what they pay to maintain the property. If they think they won’t get their profit, they’re less likely to be willing to loan money (or property) to you.
Downsides of no credit
When you have no credit, you’re a blank slate. Lenders have no idea at all if you’ll pay them back, because you have no history showing how you’ve handled your finances in the past. Lenders like to know what to expect, and when they can’t fit you into an algorithm, they get nervous. This may make them less likely to extend you credit.
How to fix bad credit
Bad credit is hard to fix, because the only solutions are time and discipline. You may have to get a secured credit card with co-signer or credit cards for bad credit to begin the process of rehabilitating your credit. You need to make all of your payments on time, make sure that you don’t use more than 30% of your available credit, and … wait. Over time, if you keep making your payments on time and slowly get access to better credit, while behaving responsibly with it, your credit score will start to climb. It takes about 7 years for a bad credit item to drop entirely off your credit report, but you may start to see some real improvement after 12 months of on time payments without overextension.
How to fix no credit
Fixing no credit is often easier. It’s moderately easy to get a first credit card, though it’s probably going to have a higher interest rate and not many benefits. Make a couple of small purchases with it, and make sure to pay the balance off every month. If you’re going to school, consider taking out a small personal loan to cover books and living expenses – but make sure you can pay it back on time. If you keep your credit balances low, compared to your income, and make your payments on time, you’ll build up a solid credit score quickly. If you’re looking to get a car loan or a mortgage, the lender may want to see a co-signer.
Which is harder to recover from?
All things considered, it’s harder to recover from bad credit than no credit. After all, with no credit, you’re that blank slate we mentioned above. All you need to do is create good habits, and you’ll develop a solid, positive credit score quickly.
Bad credit, meanwhile, takes years to recover from. It can be an incredibly frustrating process, and even small mistakes can set back your credit rehabilitation severely. It’s best to keep your credit in good shape in the first place – but losing a job, getting divorced, or having medical emergencies can all cause you to overextend your credit and need to get back on track.
