What is Bad Credit? A Guide to Credit Reports and FICO Scores

"Bad credit" is a subjective term. To a Rolls Royce dealership, anyone with less than the most stellar credit score would be considered to have "bad credit." To credit card companies, the same person may be looked upon as having bad credit when applying for a platinum card, but not-so-bad credit when applying for a standard, run-of-the-mill card (with a higher interest rate). But how do creditors judge us on our credit in the first place? Where do they get their information?

Equifax, Experian, and TransUnion

Equifax, Experian, and TransUnion are the three major credit bureaus (also known as credit agencies or credit reporting agencies). They collect information sent to them by your creditors - credit card companies, banks and other lenders, and even landlords and utility companies if you get into debt with them - as well as any public records (bankruptcies, judgments, and liens) filed with the court. Because not every creditor reports to all three credit agencies, each of the three may have different information about you in your credit file. This means that it is possible for you to have "bad credit" in the eyes of Equifax, but not Experian, or vice versa.

Fair Isaac's & Company - Better Known as 'FICO'

Complicating things further is the fact that each of the credit bureaus has a slightly different approach to determining your credit score. They all use the same formula developed by Fair Isaac's & Company (FICO), but each of the credit agencies slightly tweak it, meaning that even if they all had identical information (which they rarely do), you would still end up with three separate FICO scores.

Regardless, your FICO score is a number between 300 and 850. Things that help your credit score include paying your bills on time, having a long credit history, and using relatively little of your available credit. Things that make you have bad credit include all of the opposites - late payments, having a short credit history, and using virtually all of your available credit - as well as more serious things like defaults (failing to pay back a loan), repossessions, judgments, and bankruptcies. Good information stays on your credit report indefinitely, but bad information can be removed (at your request) after seven years. The lone exception to this rule is Chapter 7 bankruptcies, which stay on your credit report for 10 years.

So What is Bad Credit?

The credit agency Experian defines anyone with a FICO score of 539 or below as "high-risk." Historically, about 19.1% of people with "high-risk" credit have defaulted on their loans. By comparison, people with "AA" credit, (a FICO score of 760 or higher), default on just 0.2% of their loans. Clearly you can see why lenders feel they must charge higher interest rates to people with bad credit - they are much more likely to default. If a lender made five loans to "high-risk" borrowers, chances are that one of them would not pay him back. Therefore, the other four have to pay a higher rate to compensate the lender for the borrower who defaults. By contrast, a lender can make 500 loans to people with "AA" credit, on average, before one of them defaults.

What To Do if You Have Bad Credit

First and foremost, you need to determine whether or not you have bad credit. If you do, then you can begin taking steps to improve your credit rating. There are resources available at this site that allow you to view your credit reports and FICO scores, and once you're armed with that knowledge, you can use additional resources available through Debt Relief USA to begin taking steps to improve your credit.