Lenders often take extra precautions when dealing with potential borrowers with no credit or bad credit. Both can be disadvantageous because only those with the best credit receive the best deals.
Many people question whether one or the other is the better situation.
Both have distinct disadvantages, but one is better than the other. To understand that better, we need to look at what both mean.
The Differences Between No Credit and Bad Credit
A person with no credit is an unknown variable. The lender doesn’t have enough information to justify whether the deal will be honored or not.
There’s more prediction involved, and they don’t like that because lending is all about risk management. It does not matter whether you believe you can pay because your credit score always speaks louder than words or actions.
Having no credit means there is a risk when dealing with you. Lenders want assurances, and you may find yourself in a situation such as:
- Getting higher interest rate offers than normal
- Getting turned down for some of your loan applications
- Finding difficulty with rentals and places to live
- Higher deposits required for utility
- Very few options when it comes to emergency money
- Lenders wanting a co-signer, guarantor, or collateral
While it isn’t an ideal situation, you'll only have to endure it at the start. As you begin making your payments and establishing credit, you could find yourself with a better score.
You’ll have to endure dealing with these situations for a while. Once you have a good credit score, you can seek out better opportunities.
For example, you can lower your loans interest rates by refinancing through another deal. With a better credit score, you have more options.
“Lower interest means fewer payments and more financial control.”
What About Bad Credit?
Bad credit means that you have a lower score than average on the credit score scale. Numerically, it is a score lower than 630.
Lenders are also hesitant to deal with people with bad credit because they know they may not fulfill their end of the deal. Their actions in the past mean that they are high-risk borrowers.
It does not matter if their lower score was because of an accident or unexpected event. Lenders only look at the score and not the circumstances surrounding it.
People often get a low score because of a mistake while handling credit. Some examples include:
- Bankruptcy
- Late or missed payments
- Neglecting an account
- Becoming a target by a collection agency
- Having a very high debt
- Going beyond 30% of your credit limit.
The best thing one can do is work to increase their score. There are many strategies to help with it, but it all takes time. Building credit is all about commitment and diligence.
What Your Credit Score Means
The measurement of credit is called the FICO Score. It is a set of three numbers representing how trustworthy you are as a borrower.
It takes into account debt, payments, and more. It involves all good and bad circumstances, which translate to the score. The ratings are as follows:
- Very Poor: Less than 580
- Fair: 580-669
- Good: 670-739
- Very Good: 740-799
- Exceptional: 800 or more
Bad credit is a struggle many people have in the U.S. Most lenders will accept scores that fall in the Fair category though below average.
Lower scores also mean more barriers and higher fees associated with any deals you get.
What is Worse: No Credit or Bad Credit?
While both situations can hold you back, lenders often view one in a bad light compared to the other. Having bad credit is the worse situation out of the two.
The reason is that you already have a record that shows you are risky. Lenders are more willing to work with someone with no information than someone with a proven low score.
A person with no credit will need a way to give a lender more assurance. For example, providing collateral for a loan will show the borrower’s confidence in paying off the loan.
A bad credit score acts as a barrier for many things. A borrower may not find any home loan options because lenders need to work with a minimum credit score.
How to Improve Your Credit Score
Having no credit means that you’re starting with a blank slate. You only need to build a solid foundation to ensure that you’ll get better offers down the line.
Lenders provide several options to help people start. Here are some you may want to consider to improve your score:
- College Student Credit Cards - As the name implies, these are cards reserved for those still studying to get their degree (or advanced degree). These credit cards often have low entry barriers, and those with no credit often get them. They also have lenient conditions for repayment and may even have low-interest rates. It all depends on the lender, so the best move is to check the options available.
- Secured Credit Cards - Secured cards are another option many no-credit borrowers take. To apply, you’ll need to provide a cash security deposit which will act as collateral for the card. Your credit limit will often be what you provided. If you fail to pay the card and default, the lender will take the deposit as part of the agreement. Secured credit cards are easy to apply for because lenders expect the collateral to be enough. It’s also a way to get a card early and begin building a credit score.
- Co-Signer Loans - A co-signer acts as the lender’s guarantee that someone will pay the loan. If you are unable to fulfill it, the co-signer gains the responsibility. The co-signer must usually be in good standing with their credit. However, there are risks involved for the person signing with you. It means that they’re taking the full brunt of the loan if you suddenly back out. That can destroy relationships even with the best intentions. Very rarely do you find someone that will want to co-sign outside your family or circle of closest friends.
- Credit Card Authorization - After a credit card owner builds a good reputation on their card, they can authorize someone else. It’s a way for you to make your mark and start building your score. Eventually, the credit bureaus will record your score, and you’ll have established something to work with future loans. It may take some time, and payments will not increase your score the way a personal card can. You also won’t be paying for your purchases, meaning you’ll have to provide your payments to the one that authorized you. The person could also refer you to the lender. Even without a credit score, the lender can have a better consideration because of the one who recommended you. It’s an alternative path to getting your first credit card.
- Credit Builder Loans - A credit builder loan represents a different take compared to other offers. As the name implies, their specific goal is to help improve your score. Instead of getting the money right away, the lender holds on to it until you fulfill your payments. For example, you borrow around $1000 and have a goal of paying it in six months. After you complete repayment, the lender then releases the funds to you. “You get your money back and have built months’ worth of good payment history.” However, it does come with fees and interest rates, so make sure to account for that. Many stay away from this as it is an expensive path that solely words to build credit and nothing else. It may be a good option if that is your goal. You also want to ensure that the lender is reporting your payment history. The three credit bureaus should have information on your payments for it to matter. Ideally, you'd ask this question before going through with the loan.
What About Those with Bad Credit?
Those with a poor credit score may need to approach improving it differently. Negative marks on your credit are often hard to remove, so it can be challenging to turn things around.
On average, it takes seven years before negative marks begin falling off the record. While you’re waiting for that time, you can re-establish yourself.
You’ll have to fix any credit problems you have while also building positive accounts. It will take time, but there are some things you can do.
Lower Your Debt to Income Ratio
One of the ways you can begin affecting your poor credit score is to lower your debt to below 30%. You’ll notice how some lenders begin reporting negative marks if you’ve exceeded that percentage on your credit card.
Many experts believe that going beyond 30% means that a person doesn’t know how to manage debt.
Lowering your debt also improves your purchasing power and gives you more control over your finances. One of the best things you can do right now stops all the factors lowering your credit score.
You can begin paying off debt with the highest interest first, as they’re costing you a lot in fees. Once you lower the principal, they'll charge you lower despite their rates.
Review Your Reports
All three credit bureaus offer a free report for you to get each year. Since the COVID pandemic, each bureau offers a free download once a week.
Errors, redundancies, and missing information are possibilities within the report. You should always check for these as they may be impacting your credit even when it’s not supposed to be the case.
Getting your credit report will not affect your score in any way. Reviewing and correcting any mistakes can retroactively improve your ratings.
It’s one of the faster ways to push your credit to a positive area. Agencies have a way for you to make disputes on errors. You can report any of the following:
- Expired debt
- Incorrect account status
- Incorrect information
- Registered accounts that don’t belong to you
- Establish New Credit Lines
Most people with bad credit scores often have few ways to improve them at the moment. It’s because most of their previous lines have expired or broken down, leading to their score.
If you have nothing to build credit on, it will be impossible to move up.
Treat your approach like you have no credit. You can use any of the following methods:
- Get a Secured credit card
- Apply for a Credit Builder loan
- Get credit card authorization
- Apply for a collateralized loan
- Get a co-signed loan
While you may lose access to some of your options because of your current score, many of these moves are still possible. Lenders want assurances, and these loans are easier to apply for than your traditional loans.
Each option can provide you with months of positive payment history which affects your score.
Putting It All Together
Building your credit score requires patience, as it will take time. If you don’t have any credit ratings yet, you’ll need to wait six months before you become eligible to get a FICO score.
If you’re working towards rising from a bad score, that will also take time.
All you need to do is maintain good payment habits and avoid unnecessary risks. You may also want to build an emergency fund you can use if you encounter a problem that endangers your consistent payments.
A good credit score provides many opportunities that many cannot access.
If you’re looking to improve your credit score, consider consulting with 121 Financial Credit Union. We have different programs and options available that can boost your rating to better categories.