Actually, that's not entirely correct. The meaning of heath, among other things, is basically a cow pasture, so yes, a heathen was someone who lived on a heath, i.e. a farmer. Although the religious usage of Heathen actually wasn't applied to people living in christendom; if they practiced non-christian practices, they were pagans or heretics, but by the late Dark Ages, early medieval age there really wasn't many pagans, heretics, heathens or otherwise within christendom itself. Instead, Heathen was applied to the Germanic people of the north.

Thus, early Saxons were Heathen, the Vikings and far flung Norse regions were heathen, but your average farmer who did a little dance to the Gods of fertility was not. The definition of Heathen, as stated above, a practicer of non-Christian, is a misconstructed term that we use today, not then. The orignal meaning of Heathenism was, more or less, of, or pertaining of, the old religion. The old religion referred to here was the Norse religion, what is today known as Asatru. The reason it was referred to as the old religion is after the collapse of Rome, the Germanic tribes spread throughout most of Europe and brought their religion with them. Thus, after having a mix of Norse Heathenism and Roman Catholicism, to becoming almost completely catholic, the "old" religion to many people would have been the Norse religion.

By the time of the crusades, Heathenism had been, more or less, eliminated. The Saxons had long been converted, as had what was left of the Vikings, and Scandinavia was crawling with missionaries. Hence, the word Heathen was more or less meaningless, and so its aim was modified. Instead of the Norse, the crusaders directed it against Islamic people, hence the phrase that is often used in movies and games: "Death to the Heathens!". As to when the word changed into the meaning we use it today is unknown, but it most likely occured during the Rennaisance period, although to this day, Asatruists refer to themselves as Heathens.