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Major Reasons for Bad Credit Scores: Part 1

Your credit score is a more integral part of your daily lives than most of us even know. This ‘rating’ like many we have received in our lives; think grades and employee ratings carries even more implications on our financial lives. From restricting or limiting access to capital (credit) or services (cell phone, cable, car insurance) and the associated costs.

It is imperative that we learn the ways to build our credit scores and profiles the correctly, and part of gaining that knowledge is also being aware of some of the major reasons for bad credit scores. Bad credit scores can be defined by different standards but we will use the FICO (Fair Issac Corporation) definition as this firm has created the industry standard model for consumer credit ratings. Bad credit is generally considered a score below 580, for some firms their threshold is 620 or below. The current FICO general credit score ranges from 300 – 850. There are some individuals who may not have credit history and therefore no credit score can be calculated for those individuals. We will save that discussion for another blog.

Having good credit displays to institutions or individuals that you have a higher chance of being able to meet the requirements of whatever financial transaction you may potentially engage in. This is not to say that individuals with higher credit scores do not default on their obligations or that individuals with lower credit scores will default on theirs. It is simply a numbers game and relies on probabilities to measure associated risks, and history has usually proven that individuals with particular risk characteristics have a certain chance to live up an agreement.

Below are a few of reasons that may lead to individuals having a ‘bad’ credit scores and therefore could limit your access to capital or services.

Bankruptcy

This is one of the most significant negative events on an individual’s credit report and one that firms always look for in reviewing an application for loan or services. There could many reasons for a bankruptcy including divorce, loss of income, medical bills or other reasons. But filing bankruptcy can typically stay on your credit report for between 7 – 10 years so the effects of reducing your existing debt can limit your ability to get new credit during the time period the bankruptcy will be on your credit. This does not mean you will not have access to any credit, it may simply mean that most traditional institutions would pass on offering credit products for at least a few years and the products that may be available, may require some additional upfront deposits or collateral. Try to avoid this at all costs but if needed seek the right legal counsel to best guide you in this process and understand all the implications on your current and future financial needs.

Missed Payments/Collections

I will lump missed payments and collections together although they are not exactly viewed in the same way. Not all missed payments are created equal, there are factors that are considered such as how late was the missed payment, did the account end up in collections, what was the amount of the missed payment and has there been patterns of missed payments. With all that said, the best advise is to not miss a payment if you can avoid it. Missed payments can signal to a financial institution that you are having trouble meeting your obligations and that may cause them to be more cautious with creating a new loan or other obligation with you. Sign up for auto-payments if you can and set up payment reminders, as well as check your accounts to see if payments have been processed at least on a monthly basis.

Collections are also a major concern as this typically occurs when an institution has tried for some time to collect payment for an amount that is owed. They may transfer that amount to their collections team, ‘sell’ the amount owed to a collections firm, or contract with a collection firm to recover as much as possible and charge a fee or percentage for the collection.

This shows also is a red flag for many institutions but again there are some exceptions here, has the collection been paid, how long ago was this collection placed on the report, the amount of the collections. If you have had a collection and have paid it off, you could request that the collection be removed from your credit report. If a large collection has recently been placed on your account, this would typically reduce your credit score and raise some significant concerns.

Unexpected life Circumstances

Life can have many unexpected circumstances that we may not be fully prepared for, such as loss of a job, significant medical issues, or significant car repairs are a few of these issues. These situations occur everyday for many individuals and can have significant financial implications that could lead to significant debt or credit cards burdens. If one does not have significant savings that can be leveraged to help offset these expenses many consumers turn to credit cards to get through these periods. Often the associated expenses can be much more than are initially expected especially in light of changes in healthcare costs and coverage. If these balances are placed on credit cards they can increase your credit utilization and reduce your score significantly. These circumstances are difficult to predict but happen too often to ignore. The best course to prevent this would be to create an emergency fund that can be used to absorb some of these initial costs. This requires discipline and financial savvy that we will teach when our platform rolls out.

Thank you for spending some time and learning a bit more about some of the negative traits that affect your credit score. Part 2 of this blog will be coming shortly with a few more items to watch out for.

For practical tips and advice on how you can realistically improve your credit score, subscribe to our blog and refer us to friends and family so they can get a better handle on their finances.

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