In short, you are better off with no credit than with a bad credit and score. However, both situations have their own challenges that you should keep in mind when trying to apply for credit.
If you’re faced with either option, you’ll have a hard time getting approved for a low-interest credit card. They may not approve you at all. What’s more, you may also have trouble qualifying for housing, opening utility bills, or even getting a job in certain industries, since credit history is often used to gauge your reliability with money in general.
Here’s how each situation specifically affects your finances and what you can do to build or rebuild your credit.
Bad credit vs no credit
In general, people with bad or no credit face challenges when applying for certain credit cards, especially those with low or promotional APRs, lucrative rewards or other benefits. Lenders consider these consumers riskier than those with good credit, but for different reasons.
A person with bad credit has shown that they have struggled to meet their obligations in the past. “From the lender’s perspective, if the consumer has bad credit, the lender has information that suggests the consumer may not repay the money as agreed,” says Freddie Huynh, vice president of data analytics at Freedom Debt Relief. With bad credit, recovery can take months or years, depending on the extent of the damage.
On the other hand, a consumer with no established credit history has not given the lender any information to evaluate. The good news is that it only takes six months to build a credit history and credit score. Either way, the lender will increase the interest rate and/or offer a lower credit limit to compensate for this uncertainty and additional risk.
Bad credit history
A “bad” credit score is often considered anything below 580 on the Fair Isaac Corporation (FICO) scoring model. FICO scores are the credit scores used by most lenders and range from 300–850. Here’s how those results break down:
- Bad: 300–579
- Fair: 580–669
- Good: 670–739
- Very good: 740–799
- Exclusive: 800–850
Another common credit scoring model is VantageScore. This system works similarly to FICO, although it is not as common. Still, it’s good to know where your score falls on the VantageScore scale:
- Very Poor: 300–499
- Weak: 500–600
- Fair: 601–660
- Good: 661–780
- Excellent: 781–850
7 Bad Credit Repair Tips
If you have bad credit, there are several steps you can take to improve it over time.
1. Make all your payments on time
The biggest factor that affects your credit score in both the FICO and VantageScore models is your payment history. Paying your bills on time and in full will have a positive impact on your credit score. And it’s not just your credit card — you should aim to keep up with all your bills, including utilities, phone and rent or mortgage. Missing even one payment can cause serious damage to your credit.
2. Use credit responsibly
You might think that avoiding your credit card after a mistake will protect your score, but that’s not true. Credit bureaus rely on your current credit activity to predict how you will do with credit in the future. So instead of avoiding credit altogether, consider charging small amounts that you can easily pay off right away.
3. Lower your loan utilization ratio
The second biggest factor in determining your FICO credit score is “amounts owed,” or how much credit you use compared to the total amount of credit you have available. This is also known as your credit utilization ratio, which is the amount of revolving credit you use divided by the total credit available to you, expressed as a percentage. For example, if you have a credit card with a limit of $5,000 and a balance of $500, your APR would be 10%.
Your credit utilization ratio signals to lenders that you are too dependent on borrowing money to make ends meet. A good rule of thumb is to keep your credit utilization under 30%, according to Experian.
4. Consider applying for a secured credit card
Secured cards are designed for people with less than good credit. They are secured by a cash deposit and usually come with a lower credit limit. These cards generally have stricter eligibility requirements than unsecured cards. A secured card can be a useful tool for rebuilding your credit, especially if you consistently pay your bill on time and in full. Just make sure your particular card reports activity to the credit bureaus.
5. Avoid accruing interest and fees
Allowing your debt to grow due to high interest rates and late fees makes it much more difficult to manage. These fees can quickly add up and cause your loan utilization ratio to rise. Also, if you let your balance get too big, you may have trouble keeping up with your payments. You can avoid this situation by keeping your credit utilization to a minimum and paying your balance on time and in full each month.
6. Pay off outstanding debt
Any debt you owe will affect not only your credit but also your ability to direct funds to other goals, so it’s important to pay off the debt as soon as possible, especially if it carries a high interest rate. “If you’re recovering from a financial crisis, one of the most important things to do is develop a plan to pay off any credit card debt,” says Huynh. Not only will this lower your utilization rate, but it will make it easier to meet your other financial obligations and future goals.
7. Monitor your credit regularly
Checking your credit reports can help you understand which factors affect your credit score the most. For example, there could be a collection account or even an error on your credit report that lowers your score. Reviewing your reports regularly can help you determine which factors you need to work on to improve your credit. You can get a free copy of your credit report from each of the three major credit bureaus (Equifax, Experian and TransUnion) at annualcreditreport.com.
No credit history
No credit history means there is no information about your credit usage reported to the credit bureaus. Therefore, your credit score cannot be generated and does not exist. This happens when you’ve never borrowed money before, such as a credit card, mortgage or car loan. This can also happen if you have only used credit for a few months.
7 tips for building credit from scratch
The good news is that without a credit score, you can start building good credit in just a few months as long as you adopt responsible spending habits.
1. Learn the basics of credit
Before you dive headfirst into applying for a credit card, take some time to learn what credit is, how best to manage it, and how it affects your everyday life. Getting a solid understanding of credit can help you make good financial decisions when it comes time to apply for your first card.
2. Check your credit reports
If you’ve never pulled your credit reports before, it’s a good idea to take a look and see what information is used to generate your credit score. Keep in mind that each credit bureau collects your data independently, so you need to make sure the information is consistent across your reports. You can get a free copy of your credit reports every week until the end of 2023. (After that, free reports will only be available once a year.)
3. Receive a report on payment activity
Even if you don’t have a credit card, you can start building your credit score by reporting your current housing or utility payments to the three credit bureaus. This can be done using a third-party service like Experian Boost, which allows you to enter recurring bills into your Experian report. Remember: Your payment history accounts for 35% of your FICO credit score, so make sure you make your payments on time.
4. Consider applying for a secured or student credit card
Secured credit cards are a solid option for people with no credit as well. Again, these cards are usually easier to rank for and are secured by a cash deposit. If you’re in college, a student credit card can be another way to access credit with more relaxed eligibility requirements.
5. Avoid carrying debt month after month
One big credit myth is that you have to have a balance to build a credit history. But this is not so. It is wise to avoid charging transactions to your card that you cannot reasonably pay in full and on time each month. This will help you avoid unnecessary interest charges that can quickly add up and keep your usage low. Don’t worry: you’ll still get credit for using your card even if you pay it off right away.
6. Add yourself as an authorized user
If you have a trusted friend or family member, such as a parent or spouse, they may be able to add you as an authorized user on their credit card. This gives you the same spending privileges without the legal responsibility of paying the balance. You also inherit a portion of their positive credit history, allowing you to build a score over time. You don’t actually need to use the card to take advantage of your credit. Just make sure the primary cardholder uses it responsibly as their mistakes will also affect your score.
7. Monitor your credit score regularly
Monitor your credit score to make sure you have one, and your responsible use of credit helps it improve over time. Note that credit reports do not include your score. You can pay FICO to get your score, but many banks, credit unions and credit card issuers offer free FICO scores to customers. So check with your financial institutions first.
The taking
It’s generally better to start fresh with building credit than to rebuild after bad credit. While neither of these situations is ideal, the good news is that adopting smart financial habits will help you achieve the credit score you want in the future.
Whether you’re building your credit for the first time or repairing it after a few setbacks, you can start making a positive impact on your credit history right away. Focus on paying your bills on time and in full each month, using only as much credit as necessary, and monitor your credit for errors or changes. Finally, remember to be patient. “In both cases, slow and steady usually wins the race,” Huynh says.