What's "Worse?": Bad Credit or No Credit

While most of us would love to have perfect credit, few of us manage to actually pull it off. Only 1.2% of Americans can claim to own the fabled 850 FICO Score. Of course, even these credit rockstars had to start somewhere. Everyone with credit has to build their credit history from scratch, and it’s common to make some mistakes along the way. 

Is credit good or bad, overall? Short answer: it depends on how responsible you are with your credit. 

If you’re looking for ways to improve your credit, you may be wondering, which is worse: starting with no credit or rebuilding with bad credit? Here’s what to know about the limitations of both issues, so you can start working on your financial goals. 

Is no credit better than bad credit?

Truthfully, the effects of having no credit or bad credit are both pretty problematic. Neither option is universally better or worse than the other.

They’re both limiting in their own way, and you’ll probably have a hard time qualifying for your desired credit accounts if you fall into either category.

Here’s what to know about the unique downsides to having bad credit and having no credit: 

Drawbacks of bad credit

Having a bad credit score may be more dangerous than having no credit history when it lets you access accounts you’d probably be better off avoiding.

If you have a score that’s just high enough to let you qualify for a debt, you can get stuck with an excessive interest rate.

Auto loans are one of the most common examples of this issue. Borrowers with a FICO score of around 600 (a subprime score) will often still qualify for financing on their cars. However, they receive an average interest rate of 11.26% on used vehicles.

At such a high interest rate, a borrower would end up paying a whopping $2,186.37 in interest over five years on a $7,000 car loan. That’s almost a third of the principal value.

If a borrower had no credit instead, the lender would probably decline to offer them a loan, forcing them to wait until they improve their score to take on debt. This can be a better financial outcome in the long run. 

Drawbacks of no credit

While having no credit could potentially save some borrowers from excess debt, that doesn’t necessarily mean it’s a good position to be in. Sometimes you really need a loan, even if it comes with a high interest rate. In those cases, having no credit can hold you back.

For example, if you needed a personal loan to finance some emergency medical expenses, you might be able to qualify for one with a fair or poor credit score. It could be expensive (up to 36% APR) but potentially worth it in extreme circumstances.

Without a credit score, you may be limited to lenders who don’t check your credit. That can be risky, as many lenders charge interest rates well into the triple digits, such as payday and car-title lenders. 

How to improve your credit

You might think that improving your credit score would be the same whether you're starting with no credit or bad credit, but that’s not necessarily the case.

Credit building generally requires some form of credit account, and people with no credit are eligible for different ones than people with bad credit.

Recover from bad credit

When you have bad credit, there are often still several borrowing opportunities available to you. However, many of them can be prohibitively expensive.

It’s not typically a good idea to take on debt you can’t afford simply because you want to increase your credit score. Not only will it not get you what you want, it could potentially backfire and make the situation worse, trapping you in a vicious debt cycle that looks something like this:

• Bad credit scores lead to high interest rates. High interest rates lead to missed or late payments. Missed or late payments lead to worse credit, and the cycle repeats.

If you want to take out a credit account to help you rebuild a low score, you can consider using one of the following:

• Secured credit cards: These cards require a deposit, but people with bad scores tend to be older and could potentially have savings. They’re a more affordable option than loans if you can pay off the balance each month because of their built-in grace period. 

• Credit builder loans: These loans are more expensive than credit cards, since you’ll inevitably pay interest on the principal balance. However, they usually don’t check your credit, so you can probably qualify with a poor credit score.

It may take longer to reach a good credit score if you’re recovering from past mistakes than it would if you were starting from scratch. Negative records generally stay on your credit report for up to seven years, though their impact will fade with time.

Build credit from scratch

While no credit won’t get you stellar credit accounts or let you take out a mortgage any more than bad credit would, building credit from scratch can be easier than rebuilding it.

After all, everyone has to start somewhere. Many lenders are willing to give credit to young people with a solid income, even if they don’t have any credit history. Not to mention, people with bad credit are often struggling to afford their existing debts.

Starter accounts aren’t usually anything to write home about, but they’re relatively easy to qualify for when you have no credit. Some good options are:

• Student credit cards: If you’re still in college or around that age, these credit cards may be a safe bet. They’re often unsecured and offer rewards specifically designed for students, such as cashback for good grades. You can consider a cosigner if you don’t have the income to qualify.

• Secured credit cards: These are a backup option for people without a credit score, since they typically offer fewer rewards than other starter cards. Still, they’re an affordable and reliable tool.

When you’re starting from scratch, it can take time to even generate a credit score. Lenders who use VantageScore can calculate a score for you after a month of activity, but you’ll usually have to wait six months before you can receive a FICO Score.

Building good credit can take you longer than that. However, provided you make all your payments on time, you should be able to reach your goals within a couple of years tops.

Start improving your credit sooner 

Whether you’ve made some past mistakes with credit or you simply never had a credit account, there’s no time like the present to start working towards a better credit score.

Building credit is like investing: The best time to start was probably yesterday. The second best time to start is today. 

The length of your credit history is worth a significant part of your credit score (15% under FICO Score 8), so the sooner you can get started, the better.

Outstanding debt balances are also worth a significant portion of your credit score. Learn how Tally† can potentially help you pay down credit card debt faster. 

​​†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.90% - 29.99% per year. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.