Reasons Why Your Credit Score Drops

Lenders use your credit score to determine how likely you are to repay a loan or credit card. Generally speaking, the higher your credit score, the more likely they are that you should pay back your debts on time. So if your credit score has dropped, it’s important to understand why. Actions that can cause a lower credit score include late or missed payments, applying for too many new loans, or using too much of your existing credit. This article will explore these and other possible causes.

Late or missed payments

Payment history is the most important factor when a scoring model calculates your credit score. In fact, for the FICO score (the most widely used scoring model), payment history accounts for 35% of your total credit score. That’s why it’s so important to pay your loan bills on time.

While one or two late payments won’t hurt your credit score much, consistent late payments or missed payments will certainly take a toll. Even if you get back on schedule to pay, it can take some time to get back on track.

Tips on how to avoid late or missed payments

To ensure you always pay on time, consider the following:

• Set up automatic payments on your credit accounts. That way, you don’t have to worry about missing or being late with a payment.
• Create a budget and pay your bills on the same day each month. This helps ensure you have enough money to pay your bills before they come due.
• If you need help paying your bills, contact your creditors. Creditors often work with their clients to ensure bills are paid on time. If you’re having trouble paying your bills, talk to your creditors to see if you can find a solution that’s good for both of you. This could include reducing the minimum amount due, paying over time, or reducing your interest rate.

There have been a lot of loan applications recently

Applying for too many new loans in a short period of time can temporarily lower your credit score as those potential creditors run a hard inquiry on your credit report. These inquiries will remain on your credit report for two years. While each scoring model scores differently and the impact can vary by loan type, a few hard inquiries can hurt your credit score immediately. Lenders may see this as a sign that you’re under too much financial stress.

Additionally, getting a new line of credit may slightly lower your credit score because it lowers the average age of your credit accounts, which is a factor that makes up 15% of your credit score. Generally speaking, the older your accounts are, the higher your credit score will be.

How to manage your credit application to minimize the impact on your credit score

• Most scoring models take into account “rate shopping.” Multiple inquiries to your credit report when applying for a car loan or home mortgage may not have any impact on your credit score as long as those inquiries occur within a limited time frame, such as between 14 and 45 days. However, if you extend the inquiries to several months, this may have a negative impact on your credit score.
• When it comes to credit cards, resist the urge to accept every offer. If you want to apply for a particular card, check the issuer’s website to see if you meet the minimum credit score and other requirements so you don’t submit an application only to be rejected.

High credit utilization

Your credit utilization ratio won’t negatively impact your credit score unless you’ve maxed out your available credit. Your credit utilization report looks at how much credit you use compared to how much credit you have available. For example, if your total credit limit on your credit cards is $10,000 and your credit card balances total $7,500, your credit utilization ratio is 75%. That’s on the high side. Ideally, you should try to keep your credit utilization ratio below 30% to avoid hurting your credit score.

Strategies to Reduce Credit Utilization and Improve Your Credit Score

There are several ways to reduce your credit utilization and thus improve your credit score:

• Pay off your credit card balances. Reducing the amount you owe on your credit cards will increase your available credit, which will improve your credit utilization ratio.
• Keep the old credit card account open even if you’ve already paid it off. When you pay off a credit card, you may want to close the account. But doing so will reduce your total available credit, which will increase your credit utilization ratio.
• Ask your credit card issuer to increase your credit limit. Some issuers will increase your credit limit if your credit score is high enough.
• Use your time to your advantage. Opening new credit accounts may temporarily lower your credit score, but over time it will improve your score because it increases your available credit. As long as you don’t max it out, your credit utilization ratio will improve.

Changes in your credit history

The information on your credit report can go back seven years, and in some cases even as far as a decade. When something changes, it can affect your credit score—for better or for worse. For example, if you have years of on-time payments on your credit report, but recently some of your monthly payments have been late, your credit score may be affected. As we mentioned, closing credit card accounts can also lower your credit score because it reduces your available credit and increases your credit utilization ratio.

Likewise, since the scoring model favors accounts with a long payment history, adding a few new credit accounts may lower your credit score by shortening the average age of your accounts. However, as these accounts age, your credit score will improve as long as you continue to make payments.

Credit history management tips to maintain or improve your credit score

• Always pay on time.
• Keep your credit card account open even if you’ve paid off your balance and don’t plan to use the card again.
• Limit new credit accounts.
• Check your credit report regularly for errors (as described below).

Credit limit reduction

If a lender lowers your credit limit, which sometimes happens, it reduces your total available credit and increases your credit utilization ratio, which hurts your credit score.

Keep in mind that it’s generally best to keep your credit utilization ratio below 30%. If you have a total available credit limit of $10,000 and are currently using $3,000 of it, your credit utilization ratio is 30%. But if your lender lowers your credit limit, bringing your total available credit limit down to $6,000, your credit utilization ratio will rise to 50%. This could cause your credit score to drop.

How to monitor your credit limit and manage your credit utilization to mitigate the impact of a credit limit reduction

• Don’t max out your credit cards. Keep your limits low so that a credit limit reduction doesn’t severely damage your credit score.
• If one lender lowers your credit limit, check with another lender to see if they will increase your credit limit to keep your total available credit stable.
• Check your mail or email to see if there are any notices from your card issuer. According to the Consumer Financial Protection Bureau, if they lower your limit or close your account, they usually have to send you an “adverse action notice.”

Identity theft and fraudulent activity

When a bad person steals your identity and opens new credit accounts in your name, this can lower your credit score in a number of ways. The first is opening many new credit accounts at the same time. The second is defaulting on those accounts, which results in missed payments. The third is maxing out those credit cards, which increases your credit utilization ratio. Similarly, if someone steals your credit card information and charges a lot of fees, that can also increase your credit utilization ratio.

Therefore, it is important to frequently check your credit account activity to ensure that you have not become a victim of identity theft or other crime.

How to monitor your credit report and address identity theft or fraudulent activity

• Be sure to check your monthly credit card statements or more frequently online for transactions you don’t recognize.
• If you discover fraud on your credit report, call your lender immediately to report it.
• Check your credit reports frequently to look for suspicious activity. Under federal law, you are entitled to at least one free credit report each year from the three major credit reporting agencies (Equifax, Experian and TransUnion). The official website for this purpose is AnnualCreditReport.com.
• Improve your credit. If you don’t plan to apply for new credit in the near future, you can “freeze” your credit file with any of the credit reporting agencies. This makes it difficult or impossible for anyone to get credit in your name. You can temporarily freeze your file until you are ready to apply for new credit.
• If you discover fraud on your credit report, ask the credit reporting agencies to place a fraud alert on your credit report. When someone applies for a loan in your name, this will alert the lender to ask for more verification to make sure it is you.

after all

There are many reasons why your credit score can drop. These include late or missed payments, overdrawing on your credit cards, or borrowing too much at once on a new loan. Avoiding these situations can help you keep your credit score in good shape. That way, you can maintain a good credit history, which lenders will notice when you’re ready to apply for a new loan. A good credit score can also help lower your car insurance rates, get approved for an apartment lease, or land a new job.