Bad Credit: What It Means and How to Deal With It

Whether it be a car loan, credit cards or a mortgage, debt is an increasingly normal fact of life for most Canadians. In 1980, the ratio of household debt to personal disposable income sat at 66%. By 2012, that ratio passed the 150% figure (Statistics Canada) and it continues to rise. This means that households today owe on average more than $1.50 for every dollar of disposable income. Household debt is therefore an important consideration for most people.

Moderate debt is nothing to worry about when it’s under control. But if that debt becomes unmanageable, it can very quickly lead to a bad credit score, which will significantly impact your financial outlook. But, what exactly is bad credit and what should you do if you’re worried about your score? In this article we’ll guide you through what you need to know to understand and deal with bad credit when it strikes.

What does having bad credit actually mean?

All Canadian consumers with a credit history are given a credit score between 300-900, with 300 being a Poor score and 900 being Excellent. According to credit bureau TransUnion, the average credit score in Canada is 650.

Though a good credit score technically starts at 660, all consumers should aim for a score above 725. This will give you the best possible chance of being approved for credit with competitive interest rates.

Any score below 660 is going to leave you unable to access much in the way of credit other than a secured credit card. Any credit you are offered is likely to come with high interest rates.

A score between 300-559 is classed as Very Poor, and will seriously limit your access to credit lines. If this applies to you, the most important thing is not to panic. Bad credit today absolutely does not mean bad credit forever. Once your debt is under control, there are steps you can take to rebuild your credit score relatively quickly.

What are the reasons for having bad credit?

There are 5 factors affect the calculation of your credit score. These are:

  1. Your repayment history (do you pay your bills on time?) = 35% weighting
  2. How much debt do you have? = 30% weighting
  3. How long is your credit history? = 15% weighting
  4. How many businesses have checked your credit rating = 10% weighting
  5. How ‘diverse’ your current credit is = 10% weighting

If you have had issues in any of these 5 areas, it will reflect in a bad credit score. Anything from unpaid bills, through to maxing out your credit cards will impact your score. While one missed payment or other credit hiccup isn’t likely to damage your profile too seriously, consistently doing so definitely will.

Those at the very lowest end of the spectrum have usually been through a bankruptcy or consumer proposal.

Depending on why you have bad credit, your report will show a negative credit history for anything between 3-14 years. This doesn’t mean that you can’t rebuild your credit rating during this time, but it does mean that it will take time to get back to the best possible scenario.

If you’re curious to read more about how credit scores are calculated, you might find it helpful to read this guide which discusses the topic in more detail.

How to spot the warning signs of bad credit

There are 4 main areas that signal a risk of bad credit.

1.  Poor credit card usage

Improper credit card use is one of the biggest issues affecting Canadian consumer credit scores. Whilst regular use and full monthly repayments are a great way of building a credit score, the inverse can be disastrous for your credit rating.

Minimum, late or missed payments are all going to impact your score. The same is true for maxing out your cards. Both of these behaviors demonstrate to lenders that you are a risky person to give lend to, and can take months or even years to recover from.

2.  Defaulting on loan repayments

Defaulting on your loans is a credit score killer. Miss a car loan or mortgage payment and you will not only be facing a bad rating, but – if you constantly miss payments – you also risk repossession, which will remain on your report for 7 years.

If you suspect that you are at risk of missing a loan payment, it’s essential that you notify the lender right away to negotiate a payment plan to minimize the impact to your rating.

3.  Repeat applications for credit

You may think that applying for additional credit will help you keep up with your bills and avoid late payment charges. However using more debt to keep up with existing debt is never a good idea. Too much debt and your credit score will get worse, not better.

If you are turned down for a loan you might think it’s OK to apply somewhere else. This too is a bad idea. Repeat requests for credit will result in multiple credit checks, called inquiries, by multiple lenders. Too many inquiries will harm your credit score even more.

4.  A consumer proposal

A consumer proposal occurs when a consumer is unable to repay all their debts at the same time, and negotiates a revised debt repayment plan through a third party.

Though it’s not the same as a bankruptcy, and in fact is a responsible step to get your debts back under control, a consumer proposal will remain on your credit report for between 3-7 years, depending on the time you take to pay off your liabilities.

5.  A Bankruptcy

Bankruptcies are sometimes the only choice for people who are experiencing serious debt issues. However, should you need to go down this route, it will remain on your report for between 7-14 years, depending on whether you have been bankrupt in the past or not.

Because of the long-term impact to your credit rating, you should always seek advice from professional personal finance advisors before declaring a bankruptcy. It might be the best option for you, but it’s important not to jump the gun.

What options are available to you?

First things first, if you don’t already know what shape your credit report is in you should order a free copy from the two Canadian credit bureaus. Here’s a guide on how you can do so.

If you have unmanageable debt and are worried about a bad credit score, the first step should always be to recognize the warning signs and seek professional advice from a financial advisor. At that point you can deal with the debt through various options, which can be anything from short-term payment plans with the lender, right through to a consumer proposal or bankruptcy.

If you are facing bad credit, don’t panic. Though it will take time and perseverance, you can and will be able to rebuild your credit score. If you have a damaged credit score and are considering working with a credit repair company, first read through this article about why we think you are better tackling the issue on your own.

Rebuilding your credit takes time. But with the right professional support and persistence, you’ll be on the road to the golden 900 as quickly as possible!