Even if you’ve made a few credit mistakes in your past and you’re dealing with a low score, there are several ways to revamp your score. Credit scores range from 300 to 850. The higher your score, the easier it is to get financing. Some people underestimate the importance of getting financing. But without loans, many of us would be unable to accomplish a lot of things.
For example, if you’re buying a house you might pay $100,000, $200,000 or $300,000, depending on where you live. Do you have this type of cash in the bank? In most cases, you don’t. So if you’re planning Do you know what causes bad credit? Don’t feel bad if you don’t. The truth is, credit literacy isn’t taught in many high schools. Additionally, many people don’t learn credit management from their parents. As a result, they grow up and become adults who don’t know the wrong and right ways to manage their credit. And if you don’t have credit knowledge, you’re more likely to make mistakes.
But there’s good news. Eon buying a house, you have to apply and qualify for a mortgage loan. And given today’s lending standards, you need an acceptable credit history to get a mortgage loan.
However, getting a mortgage isn’t the only reason to be concerned about your credit. Bad credit also makes it harder to get auto loan financing and other loans. Even if you’re able to qualify with bad credit, you’ll pay a much higher interest rate, which means you’ll pay more for the loan in the long run.
Bad credit also makes it harder to get a mobile phone contract. And if you apply for work in the finance industry, an employer might not consider you for a position if you have a poor credit history.
But it isn’t enough to understand the consequences of bad credit, it’s also important to understand what causes bad credit. If you know what causes bad credit, it’ll be easier to avoid situations that can drive down your credit score.
Paying Your Bills Late
It doesn’t matter if you’re paying a credit card bill or a utility bill, if you get into a habit of paying bills late, you’ll damage your credit score.
Creditors are extremely serious about timeliness. If you miss a payment by a few days, you’ll get hit with a late charge. Being late doesn’t necessarily result in credit damage. Creditors won’t report lateness to the bureaus until a payment is 30 days past due.
A late payment on your credit report knocks down your credit score. And if a potential creditor checks your report and sees that you’ve been late a few times, the creditor may conclude you’re not the right candidate for a loan. The more late payments you make, the more points you lose.
Consequences of a late payment include:
- An inability to get future financing
- You’ll pay higher interest rates on loans and credit cards
- Your credit card company might lower your credit limit
Since timeliness makes up 35% of your credit score, you need to avoid late payments.
Too Much Consumer Debt
If you’re curious about what causes bad credit, you might be surprised to learn that having too much debt can also hurt your credit score. The amount you owe creditors make up 30% of your credit score. So the more you owe, the lower your score.
It’s easy to get in over your head, especially if you have a credit card with a high credit limit. Yes, a credit card can put everything within your reach, and it becomes easier to make purchases. But when you max out a credit card or keep your balances close to the credit limit, you can unknowingly drive down your credit score.
It might not seem like a big deal, especially if you make your credit card payments on time. But with high balances, your credit score won’t be as high. If you apply for a job and the employer checks your credit report, he might not be comfortable hiring you if you have a mountain of credit card debt, especially if the job involves working with money.
Cosigning a loan
It doesn’t matter if it’s your child, sibling or a friend, cosigning a loan can drive down your credit score. Cosigning not only increases your debt-to-income ratio — which can also have a negative impact on your credit score — if the primary signer defaults or skips a payment, your credit score will suffer.
Although you’re not the main account holder, you’re just as responsible for this line of credit. You’re actually next in line to make the payments if the primary signer can’t. Cosigning is a big responsibility, and unfortunately, it might not end well. Just know that this account will appear on your credit report. So any credit activity associated with this account — whether good or bad — can affect your credit score. Only cosign a loan if you’re willing and able to cover the debt if the primary signer defaults.
Ignoring past due accounts
If you’re wondering what causes bad credit, it’s important to understand how past due accounts can damage your credit score. If you default on a credit card or another bill, your creditor will send letters and call your house to collect payment. After a while, the collection attempts might stop. But this doesn’t mean the creditor has forgotten about the debt.
Understand that balances don’t disappear into thin air, and creditors don’t forget. In all likelihood, the creditor will sell your account to a collection agency. When this happens, a collection account appears on your credit report, and this negative item can stay on your report for up to seven years. Collection accounts are extremely damaging to credit scores, so you’ll want to avoid these at all cost.
If you have a past due amount, call your creditor and set up a payment arrangement. By communicating with your creditor, you can usually avoid a collection account. If you have an account in collections, pay off this account and then ask the creditor to remove the collection account from your credit report.
If you have more debts than income, you might think a bankruptcy is the only option. Bankruptcy can give you a fresh start or restructure your current debts. Depending on the type of bankruptcy and whether you qualify, a bankruptcy judge might erase your debts and wipe the slate clean. Or you might have to pay a percentage of your debts under a new payment plan. No matter the outcome, a bankruptcy can stop collection attempts and reorganize your debt. But unfortunately, it can cause major damage to your credit score.
Filing bankruptcy can take as much as 250 points off your credit score. Additionally, a bankruptcy stays on your credit report for up to seven to 10 years. During this time, it might be harder to get mortgages, auto loans and even an unsecured credit card. On a more positive note, the effects of a bankruptcy decrease with time. So if you make smart credit decisions after filing bankruptcy, you can potentially recover and build a good credit score in about 2 to 3 years.
Foreclosures and repossession
If you understand what causes bad credit, you can take steps to avoid severe credit damage. Like a bankruptcy, a foreclosure and repossession also damages your credit score. In both cases, a bank takes back property because you’re unable to keep up with monthly payments.
You might apply for a mortgage or auto loan with every intention of paying back the creditor. But if you lose your job, go through a divorce or can’t work for other reasons like an illness, your income might drop and you can fall behind on payments. You might be unable to change your financial situation, but you can take steps to avoid a foreclosure and repossession.
If your finances are in the toilet and you don’t see improvement in the near future, unloading your possessions is one of the best ways to avoid foreclosure and a repossession. For a mortgage loan, this includes selling the house or renting out the property while you find a cheaper place to live. To avoid a repossession, you can look into selling your vehicle. Some dealerships will buy back used cars, or you can sell the car on the private market.
Erroneous information on your credit report
It might come as a surprise, but creditors can make mistakes. For that matter, your credit report might include erroneous information. It is extremely important to check your own credit reports at least once a year for accuracy. You can order your credit reports from Annual Credit Report, or you can request reports directly from the three major bureaus — Experian, Equifax and TransUnion.
You should check every line of your credit report for accuracy. This includes looking at your account balances and your payment history. Since identity theft is a real problem, you also need to check your report for fraudulent activity or unfamiliar accounts.
With identity theft, someone can steal your name, credit card numbers or Social Security number and accumulate debt in your name. Identity theft can go on for months or years before you notice a problem, and it can completely ruin your credit score. Sadly, some people never check their credit reports, so they don’t learn about identity theft until they’re rejected for a loan or credit card.
When it comes to your money and your credit, you have to be proactive. One of the best ways to be proactive is understanding what causes bad credit.
Fixing Your Credit History
Fortunately, having bad credit isn’t the end of the world. It might seen as if you’ll never improve your credit score. Just know that many people have successfully built a strong score after a long history of poor credit. However, you have to know the right and wrong ways to manage your credit.
We’ve already discussed a few simple ways to improve your credit, such as:
- Paying your bills on time every month
- Paying down consumer debt
- Disputing credit report errors
But these aren’t the only ways to build a better score. Credit scoring models take other factors into consideration, such as the type of accounts you have and your number of new accounts. For that matter, if you’re trying to build a better credit score, it helps to diversify your credit. In other words, don’t have just one type of credit. You should have a mix of credit types. For example, you might have one or two credit cards and an installment loan like a student loan, an auto loan or a mortgage.
It’s important to understand how applying for too much new credit can hurt your credit score. For every credit application you submit, your credit score might drop by 2 to 5 points. Additionally, these inquiries stay on your credit report for up to two years.
One or two credit inquiries a year isn’t going to damage your credit score. But if you apply for too much credit in a short span of time, your score won’t improve. As a rule of thumb, only apply for credit when absolutely necessary.
Challenges of Having No Credit History
As we consider what causes bad credit, it’s important to realize that having “no credit history” also creates problems when applying for financing. Some creditors group people with no credit history in the same category as people with bad credit.
If you don’t have a credit history or score, look into getting a secured credit card. These credit cards are offered by various banks, and while they do require a security deposit, you can get approved with bad credit or no credit. As long as you make your minimum payments on time every month, the bank will update your credit report with positive activity — and it’s this positive activity that increases your credit score.
Bad credit can limit your financing options. But with determination and an understanding of what causes bad credit, you can increase your score and join the ranks of many people who have excellent credit.