Which is worse: Bad credit or no credit?

Erin Bruehl | July 9, 2021

A credit score is important for everyone, whether you are a young adult who is starting your financial journey, a person who is working hard to make ends meet, or someone with a healthy bank balance.

A good credit score, a bad credit score, or having no credit at all can determine whether you’re approved for a car loan, a mortgage, or a new credit card, or you’re rejected because you’re not financially trustworthy enough.

While good credit is good, there are differences between having low credit and no credit at all. It is important to know these differences and how you can rectify these respective situations to improve your financial standing.

Credit Scores

In order to have a credit score, you must meet three key criteria:

You must have a bank account for a minimum of six months.
The account should report activity to a credit bureau for six months.
The account cannot have been made with a person who has since died. In other words, the credit report can’t be connected to a deceased person.

Credit scores give people an at-a-glance impression of how likely it is that you will pay back your loans on time. It helps lenders make a decision on whether you are financially responsible enough to trust with a loan, no matter how small or sizable.

Your credit score will be calculated from a number of different factors, including:

Your payment history.
Any unpaid debt.
The length of your credit history.
What types of credit you have.
Your applications for credit.

Some credit agencies have different policies when it comes to calculating a score. FICO, for example, will not issue you a score if you have no credit, or you haven’t had any credit activity reported to them in the past six months. VantageScore, on the other hand, will include accounts as soon as it starts reporting (no six-month period), so it might be easier to establish a credit score by using VantageScore.

Credit scores fall between 300 to 850, and a bad credit score is one that is below 630. Having a bad credit score will not automatically disqualify you from being approved for a loan, but it will make lenders hesitate before extending you a line of credit. You may be asked questions about your financial history, and you might have to explain what damaged your credit score.

Examples of what can lower a credit score include:

Late payments.
Using over 30% of your credit limit.
Defaulting on an account and letting it go to a collections agency.
Having declared bankruptcy in the past.

What Does No Credit Mean?

Not having a credit score means that creditors do not know how likely you are to pay your bills on time. The credit score helps creditors predict this behavior, which determines whether or not they are likely to trust you when you have to borrow money from them or their affiliated institutions.

Having no credit is not the same as having bad credit. In the latter case, bad credit means you do have a credit history, but it is a problematic one — usually with a lot of late and defaulted payments that have tarnished your financial trustworthiness. Improving your credit score up to the accepted “good range” is difficult but possible to do.

Creditors (and the lenders who work with them) need to have a track record of your credit history. It is very possible that you have a steady income and are reliable with money, but if you don’t have a credit history, some very important financial investments can become prohibitively difficult. You may:

Find it difficult to buy a home or rent an apartment.
Pay higher utility and security deposits.
Have limited funds for emergency expenses.
Pay higher interest rates for taking out loans.
Have loan applications rejected.

Having no credit score is also known as being “credit invisible.” In some cases, not having a credit score is the result of actually having had credit but at a point so long ago that credit reporting agencies will no longer consider that score to be a useful indicator of financial reliability, so it is not taken into account.

Having no credit does not mean a credit score of zero. In reply to a credit check, the credit agencies will simply state that they do not have enough information to generate a credit score. This might still be grounds for your application for a car, loan, or apartment to be rejected. You might be required to explain why you don’t have a credit score and offer alternative evidence that you will be financially responsible for whatever you’re applying for.

What About Bad Credit?

It is possible to unknowingly accrue bad credit. Forbes explains some of the ways this can happen, such as:

Regularly maxing out your credit cards.
Closing unused credit accounts (since this will shorten the length of your credit history and make you look like you’re too new to be trusted).
Being a victim of identity theft.
Opening too many credit cards.

There are legitimate reasons for having bad credit. Sometimes, people only have one credit card and they use it to pay everything. In some cases, paying a collections agency is seen as an acknowledgement that you have bad credit, even though paying the agency is the right thing to do. Sometimes, trying not to fall into credit card debt can paradoxically harm your credit score.

But unfortunately, even if you’ve tried to do the smart thing and lower your credit risk, this can still make you look less trustworthy than someone who has a higher credit score.

Is No Credit Better Than Bad Credit?

A person who has bad credit and a person who has no credit will experience similar challenges. However, bad credit has a more negative connotation to it.

While not having a credit score can be excused on the grounds of just starting your financial journey or wanting to avoid accruing debt, a bad credit score typically means some form of financial irresponsibility in the past. Most lenders and institutions will look at bad credit as a warning flag that you have a proven history of not meeting your credit obligations. They will look at you as a credit risk.

On the other hand, not having a credit score allows you to present your financial history as a clean slate. But no credit score will still likely raise questions about your financial past.

Overall, bad credit can be more of a challenge to overcome than having no credit. While neither one tells the whole story, lenders are more likely to make assumptions about your financial past and your financial trustworthiness with a bad credit score. Between the two, having no credit can be slightly more advantageous, but not by much.

Rebuilding Credit

In both cases, the only way out of the quandary is to build or rebuild your credit score. This could take a long time, and you will have to be careful not to make any mistakes that could show up on your financial history.

Different credit models have different trajectories. You might get a credit score in as little as a month with VantageScore, while FICO will likely make you wait for six months before issuing a determination.

If you have bad credit, your focus should be on rebuilding your credit. You should start this by getting a free copy of your credit reports from each of the three credit reporting agencies.

Look for any errors on the report, such as addresses you’ve never lived at, accounts that aren’t yours, or any payments that you haven’t made. This will allow you to dispute the errors separately with each bureau. Disputing errors with the credit agency is time-consuming and painstaking, but having these errors removed from your credit score will boost your overall rating.

It usually takes seven years for most credit mistakes to be wiped from your report, but you shouldn’t wait that long. Use secured credit cards or loans designed to help you build credit to rebuild your credit score. This will help you to make the best possible impression when a lender runs a credit check on you.

If you have no credit score, you’re going to have to build a credit report. The best way to do this is by opening a line of credit at your bank, and using that credit minimally (but frequently enough) and responsibly. However, opening a line of credit when you don’t have a credit score is a catch-22 situation.

You can still get out of this trap by using a secured or credit-builder loan. Having a cosigner for a credit card will also help you get started.

Finally, if you are always on time with your rent and utility payments, you might be able to get this evidence of your financial responsibility reported to credit bureaus. They may then be able to build a credit profile for you based on that information.

Current is a financial technology company, not a bank. Banking services provided by Choice Financial Group, Member FDIC.