Editorial Policy

Which is better: No credit or bad credit?

Erica Sandberg

April 10, 2015

QHi Erica,

I was told that it's better to have bad credit than no credit at all. Is he right? Can you tell me if this is true or not, because I don't get it. — James

ADear James, 

I've heard that, too. But do you think a nonexistent credit record could be construed as more troublesome than one where you've clearly demonstrated poor financial habits? Though neither situation is ideal, I'll have to say that having no credit history is better than a bad one — albeit, marginally.

To understand the reason, put yourself in a credit issuer's place. If you were to apply for a credit card, the issuer would check your consumer credit reports and credit scores (which is usually the FICO score). In the event you have never borrowed from a financial institution before, the issuer would not be able to assess its risk in lending you money. Your responsibility level could be anywhere from awesome to awful. Since they have no way of confirming it either way, you'd be a risky customer.Ask Erica

Bad credit, though? Well, that's a different story. Essentially, it's black-and-white proof that you're a risk. They would know this because one, some or all of the following dings would be listed on your credit reports:

  • A pattern of missed payments.
  • Defaulted loans or lines of credit.
  • Accounts that were sent to collection agencies.
  • Large sums of money owed, particularly in relation to the amount you can contractually borrow.
  • A lawsuit for a debt and a monetary judgment.
  • Liabilities such as delinquent child support, back income tax and delinquent legal fines.
  • Bankruptcy notations.

The more recently any of those events occurred, the more a credit issuer will hold them against you. The issuer may not even check your reports, but rely on just your FICO scores. These scores range from 300 to 850, with 850 as the best, and if any of the problems I described above are on your reports, your scores will be assuredly low. Whether the issuer checks your reports, scores or both, there will be no doubt about your risk level: It would set off alarms.

The good news is that an absent credit rating and a bad one can be overcome. You would just need to add positive information to the reports so credit issuers will assess you differently.

You can find out where your credit stands by getting a free credit report at AnnualCreditReport.com. Check it carefully for errors or accounts you don't recognize, and dispute any mistakes you see. You can get your credit scores for about $20 each at MyFICO.com. Your goal is a score of at least 700, which is considered “good.”

If you've never had credit before, simply apply for a low-limit secured credit card. You should be able to qualify for a card that is secured with a cash deposit. Just make sure your account activity will be sent to the major credit bureaus, TransUnion, Equifax and Experian. Once you have the card, you can develop a great credit history with a little time and effort. In a year of charging and paying your balances on time and in full, you'll have forged a fantastic borrowing and repaying trail. In two years, it will be firmly etched.

On the other hand, a bad credit reputation is more difficult to transform, but not impossible. You're not going from a neutral position to a good one, but have to work up to the start line.

First, get back on track with any current creditors, and begin to pay on time again, all while whittling down balances. Satisfy collection accounts, judgments and other negative obligations. Evidence that they happened will remain on the reports and be factored into your credit scores for as long as the law allows (in most cases seven years, but 10 years for a Chapter 7 bankruptcy). However, by adding positive data to the reports by treating credit cards and loans perfectly from this point forward, the sins of the past will eventually melt into the background.

Now you can return to the person who told you that no credit is worse than bad credit, and kindly share the correct information. Pay it forward, as they say.

Got a question for Erica? Send her an email.