If you don’t have credit history because you’ve never had a loan or credit card in your name, you might think that makes you more financially responsible.
Yet, while not opening loans or credit cards can help you avoid debt, zero credit history can work against you when you decide you’re ready to borrow money.
Indeed, having no credit – or worse, bad credit – can make getting approved for car loans, mortgages or other lines of credit more challenging. And, if you are able to to get approved, you may find yourself paying higher interest rates on the amount you borrow.
This guide explains what you need to know about bad credit versus no credit and what to expect when you have either one.
What’s the Difference Between Bad Credit & No Credit?
No credit and bad credit are both ways to describe your credit history but they have different implications on your ability to borrow money.
When you have no credit that means you have no credit score or credit report to speak of. Having bad credit, by comparison, means that you have or have had credit in your name at some point but there are negative marks on your credit history.
So, is no credit worse than bad credit? Let’s take a deeper look so you can understand the difference.
Having No Credit
Your credit report is a collection of information about your credit history. It includes basic things, such as your name, social security number and address history, along with details about your credit. For example, your credit history would include the types of debt you have or have had, how much you owe on your loans, and your payment history for debts listed on your credit report.
Your credit report and the information in it is used to calculate your credit score, which is a three-digit measure of how financially responsible you are.
When you have no credit score because you don’t have a credit history, borrowing can be problematic. You end up looking risky to lenders because with no credit score to consider, they don’t have a way to gauge how likely you are to pay back borrowed money. The good news is: There are several ways you can begin building credit from the ground up. For example, you can open a secured or unsecured credit card in your name, ask someone you know to add you to one of their credit cards as an authorized user, or take out a small credit builder loan.
5 Ways to Build Credit From Scratch
Having no credit is not an ideal financial situation, but it’s one you can remedy. As mentioned already, there are a number of ways to establish and grow your credit score even if you’re starting from scratch. Here are some steps you can take to begin building a healthy credit footprint.
1. Open a Secured Credit Card
A secured credit card is a type of credit card that requires a cash deposit to open. You give the credit card issuer a set amount of money for your deposit, which may be a few hundred to a few thousand dollars, depending on the card. That deposit doubles as your credit limit. You can then make purchases and repay them with interest. By charging purchases against your credit limit and paying your monthly bill on time, you can establish a pattern of responsible credit card use, which can help build a positive credit history.
2. Sign Up for a Student Credit Card
Student credit cards are credit cards designed for college students. These cards may be secured or unsecured and some can even offer rewards on purchases. The 2009 CARD Act requires you to be at least 21 to open a credit card, unless you’re at least 18 and have proof of income. Like a secured credit card, the best ways to build credit with a student credit card include charging purchases, maintaining a low balance or paying in full, and paying your bill on time or early each month.
3. Take Out a Credit-builder Loan
Credit-builder loans are an alternative to establishing credit with a credit card. These loans can work in one of two ways. The first option is to borrow a set amount of money, using cash that you have in savings as collateral to secure the loan. You pay the loan back and at the end of the term, your savings collateral is returned to you. The second option is slightly different. You borrow a set amount of money but instead of giving it to you, the bank holds it in an interest-bearing account. You repay the loan and once it’s paid in full, the money in the interest-bearing account, along with interest earned, is released to you. Meanwhile, your credit score can improve when you make your payments on time and pay the loan in full.
4. Become an Authorized User of Someone Else’s Credit Card
Becoming an authorized user means that you have charging rights on another person’s credit card. You don’t necessarily need to use the card to make purchases to reap a credit score benefit. The primary cardholder’s positive account history will show up on your credit report, helping to establish and grow your credit score. The caveat is that to enjoy a positive effect, the primary cardholder must pay bills on time and use the card responsibly. If they pay late or max out their card, that can hurt both of your credit scores.
5. Get a Cosigner
A cosigner is someone who agrees to apply for and sign off on a loan alongside you. Each cosigner to a loan or line of credit is equally responsible for the debt. Asking someone to cosign can help you get a loan in your name but it’s important to understand how you both can be impacted if you fail to keep up with payments. If you pay late or default on the loan altogether, the negative payment history will show up on your credit history and your cosigner’s. In addition, you can both be sued for the debt. So, if you’re considering getting a cosigner, it’s extremely important to make sure you can afford the loan payments.
Having Bad Credit
What is bad credit? Generally, bad credit refers to a credit history that includes negative marks, such as late payments or collection accounts. In terms of what is considered bad credit, it helps to understand credit score ranges. FICO credit scores, which are the scores used by 90% of top lenders in lending decisions, range from 300 to 850. According to myFICO, a poor or bad credit score is a score below 580.
Some of the factors that can contribute to a poor credit score include:
- One or more late payments
- Using a higher percentage (>30%) of your credit limit
- Applying for multiple credit card or loan accounts in a short period of time
- Closing credit card accounts, which shortens your average credit age
- Collection accounts, defaults and delinquencies
- Bankruptcies or foreclosure proceedings
- Public judgments
Repairing bad credit isn’t impossible but it can take months or even years. It may require you to take smaller steps to start, depending on your score. For example, you might be able to open a bank account with bad credit right away, but you may need to work at improving your score for a while before a credit card or loan is within reach.
4 Ways to Fix Bad Credit
If you have bad credit, raising your score should be a financial priority. Doing so can make it easier for you to qualify for credit cards or loans. It can also work in your favor if you’re looking to upgrade your bank account. For example, you may have second chance banking now but a better credit score can help you gain access to premium checking or savings products. While this can take time, here are three things you can do to get the process started.
1. Pay Down the Balance on Your Debt
FICO credit scores are based on five factors, with payment history being the most important. Second to that is credit utilization, or the percentage of your available credit you’re using at any given time. The lower this number is, the better for your score. A simple step in the right direction to improving bad credit is paying down some of your existing debt. The wider the gap you can create between your balance and credit limit, the more you can potentially improve your credit score.
2. Request a Credit Limit Increase
Paying down your balance can take time but there is a way to improve your credit utilization ratio fairly quickly. Asking your credit card issuer to raise your credit limit can have an immediate impact on your utilization ratio, since you now have a larger credit line compared to what you owe. The key to using this strategy to improve your credit score is resisting the temptation to make new purchases against your higher credit limit. Doing so can work against your credit score, rather than help it.
3. Look for Errors on Your Credit Report and…Report Them
Your credit report includes information about all of your credit accounts and you can get a report from these three firms: Equifax, Experian and TransUnion. You can also obtain a free copy of your credit report through AnnualCreditReport.com. If you haven’t checked your credit reports lately, it’s a good idea to get your free copies and review them for errors. The Fair Credit Reporting Act gives you the right to dispute errors and you can do this online through each credit bureau’s website. By law, errors must be removed or corrected, which can help your score. But this only applies to errors. Negative information related to bad credit card habits wouldn’t be eligible for dispute.
4. Pay the Minimum Payment Twice Per Month
If your credit card or loan has a minimum payment, consider doubling up on those payments each month to pay down your balance more quickly. Making biweekly payments can help reduce what you owe, improving your credit utilization ratio. You can also improve your payment history by paying on time. If you can’t do this across all of your debts, focus on doing so with the debt that has the highest interest rate. This way, you can pay the balance down more quickly, reducing the total amount of interest paid in the process.
Good Credit Is Essential
Having credit history is important because there are so many ways that credit can affect your daily life. Beyond helping you qualify for a car loan, refinance your student loan debt or get a home mortgage, you may also be subject to a credit check when you apply for a job or sign up for cell phone service in your name.
Yet, it’s not enough to just have credit. It matters whether that credit is good or bad. And, remember this: Good credit can be the key to unlocking the best interest rates on loans, credit cards and lines of credit. The less you pay in interest, the more money you can save in the long-run.