Is No Credit Better than Bad Credit?
Having a poor credit score can close a lot of financial doors for borrowers—but how does bad credit compare to no credit? Individuals with a zero credit score have not yet built any credit history, which means they are also cut off from loans, credit cards and other financial options.
So is no credit better than bad credit? Here's the difference between these two challenging credit situations.
No credit versus bad credit
Having no credit generally means having zero credit history with any of the major credit reporting bureaus because you have never applied for a loan, credit card or another type of financing. The Consumer Financial Protection Bureau, or CFPB, refers to those with no credit history as the credit invisible and estimates that approximately 26 million Americans have no credit. Credit invisibles can't meet the minimum requirements for a credit score.
For FICO®, the minimum requirement is a credit account that is at least 6 months old and reported to FICO within the past 6 months. VantageScore®, however, only needs a credit account of any age reported at any time.
In addition to the credit invisible, the CFPB estimates that another 19 million Americans have unscorable credit (PDF) because their credit history is either insufficient (thin) or too old (stale).
Bad credit, on the other hand, means there is a solid history on the borrower's credit report, but the borrower has made numerous credit mistakes. For instance, late or missed payments, charge-offs—when the creditor has written off your account as a loss—collection accounts and bankruptcies can all work to lower a credit score into a bad range. On the credit score scale of 300 to 850, scores below 600 are generally considered poor or bad.
Is no credit better than bad credit?
Although both a zero credit score and a bad credit score will pose challenges to borrowing, in most cases, it'll be easier to solve the problem of no credit than that of bad credit. This is because building credit from nothing is generally much easier than rebuilding credit after making serious mistakes.
Building new credit from scratch
To build new credit from a zero credit score, you'll need to responsibly use credit over time. This approach may seem impossible, especially because you often can't qualify for a loan or credit card if you have no credit history. However, there are several ways to establish your credit quickly—even when you're starting from zero.
Credit-establishing strategies include:
- A secured credit card, which requires a cash security deposit
- A credit-builder loan, which allows you to build savings and credit at the same time
- Applying for a credit card or loan with a co-signer
- Becoming an authorized user on someone else's credit card
- Asking if your rent or utility payments can be reported to the credit bureaus
Getting over the initial hurdle of opening an account that'll be reported to the credit bureaus is the most difficult part of establishing new credit when you have none. Once you have that first account established, making on-time regular payments and keeping your debt burden low compared to your income will help you earn a good credit score.
If you have a bad credit score, however, the process of rebuilding your credit can be more difficult. This is because you have similar barriers to accessing new credit, and it'll take some time to prove your creditworthiness before your score improves. During that time, you can expect to face greater scrutiny and higher interest rates and fees, as well as more potential for rejection from creditors.
To rebuild your credit, you'll want to start by looking over your credit reports. You can access a free report from each of the three credit bureaus once every 12 months at AnnualCreditReport.com. This is important to do because an error on your report may be affecting your credit score. Looking over your report gives you an opportunity to dispute any errors and potentially improve your score.
From there, establishing new credit can help you start the process of raising your score. Just like credit invisibles, those with poor credit can establish new credit with a secured credit card, co-signer or credit-builder loan, or by becoming an authorized user on another person's card.
Then comes the long process of responsibly managing your credit. This means making on-time payments and working to pay down debt. Making progress on these habits will eventually help improve your score over time.
The bottom line
So, is no credit better than bad credit? Both situations pose challenges, but it's easier to build up a zero credit score than a poor one. Keep all this in mind as you navigate and manage your finances in the long term.
A few financial insights for your life
This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.