Credit scores are an important part of your personal finances. The higher the credit score, the more likely it is that you will qualify for credit, and the better the terms you will receive. However, if your credit score is bad, the opposite is likely to be true.
Function
Credit scores, both good and bad, are used by financial institutions as a way to determine the credit worthiness of an applicant who often has no prior relationship with the lender. A credit score is simply a number. The higher the number, the better the credit and vice versa. This simplified rating allows a lender to extend credit without requiring a detailed review of an applicant. A bad credit score allows a lender to reject the application.
Misconceptions
There is generally some confusion regarding credit scores and how they are determined. A credit score is calculated based on the data in a credit report. The credit reports are generally compiled by one of three major credit bereaus: Transunion, Experian, or Equifax. These companies offer their own credit score calculation but it is not widely used. Usually, when people say "credit score," they are referring to their FICO score which is calculated by Fair Issac. Fair Issac does not compile credit reports, it only computes the score from a report.
Effects
A bad credit score can significantly impact your ability to get loans or other forms of credit. A bad score may lead to outright denial of many types of credit. Even if credit is available, the terms are often significantly worse than those for people without bad credit scores. These terms are usually in the form of much higher interest rates. Also, some lenders may require additional collateral.
Time Frame
Since a credit score is calculated from a credit report, the length of time an item affects your credit score is equal to the amount of time it exists on your credit report. Generally, this time period is 7 years (with the exception of bankruptcy which can remain for up to 10 years.) However, each event on a credit report can move a credit score up or down, so although an item exists on the credit report, it will not keep the score from changing.
Warning
There are many companies that offer to "fix" your bad credit score. These companies range from disreputable to complete scams. Always check with the Better Business Bereau in order to look up a company before doing business with them. Companies that claim to fix credit scores are often some of the worst rated. A bad credit score cannot be fixed by another company. A company may consolidate your loans for you and change the payment schedule, but this itself does not actually change your credit score at all. If the consolidation allows you to make timely payments, then those payments will increase your credit score. Usually, you can do the same thing for yourself by making calls to your lenders. Most importantly, remember that any company that offers to reduce your debt does so by asking your creditors to accept a lower amount of repayment. Any amount that you do not repay is reported to your credit report as having not been paid. Not paying a loan back has the most negative affect on your credit report possible, with the exception of filing bankruptcy.
Prevention/Solution
The solution to a bad credit score is to stop all activities which have a negative impact and increase the activities that have a positive impact. Make at least the minimum payment on every account each month. This alone will begin to significantly boost your bad credit score. If you can use it responsibly, open a new credit card account. Your bad credit score means that you may need to open a secured account, meaning that you deposit a certain amount with the lender for your credit. For example, you may deposit $500 with the lender and get a $500 limit credit card. Use this card every month and pay off the balance every month. That way, you have one account on your report with nothing but good data.
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