If your credit score dropped for no reason, you may feel stressed or anxious. There are many potential explanations for why this might happen, so it is crucial to investigate the situation as soon as possible.
Your credit score gets determined by the data in your credit reports, including your payment history and credit usage. Other elements, such as inaccurate information or fraud, could also impact your credit. The good news is that credit score dings are not permanent. Actions like making on-time payments or applying for a new credit card can boost your credit.
Below, we will cover 9 reasons your credit score may have dropped.
- 5 factors make up your credit score: payment history, credit utilization, credit age, new credit, and credit mix.
- We will dive into 9 potential reasons why your credit score dropped, including high credit utilization, late or missed payments, foreclosure and bankruptcy, and more.
- If your credit score has taken a hit recently, there are ways to boost your credit.
Why Did My Credit Score Drop?
Whenever new information gets added to your credit reports, that may impact your credit either positively or negatively, depending on the nature of the updated details. You can check your credit reports from each of the 3 major credit bureaus (Experian, Equifax, and TransUnion) for free at AnnualCreditReport.com.
There are also various credit scoring models, such as the FICO score and VantageScore, and companies that provide credit scores. So, you may see differences in the scores depending on where you check them. However, if you see a significant drop, it was likely triggered by something specific.
Understanding Your Credit Score
Having a high credit score gives you access to benefits, such as better terms and conditions on loans and more financial offerings. On the other hand, having a bad credit score may prevent you from qualifying for higher-quality credit products or lower interest rates. From a lender’s perspective, borrowers with lower credit scores are riskier and less responsible with money.
The 5 components that make up a credit score include:
- Payment history: Your payment history is the biggest factor that goes into your credit score calculations. It is essentially a record of how often you pay your bills on time. Late or missed payments can seriously hurt your score, while on-time payments can improve it.
- Credit utilization: Your credit utilization ratio is calculated by dividing your total credit card balances by the sum of your credit limits across all your accounts. Lenders want to see borrowers manage credit responsibly. If you have a high utilization rate, lenders may view that as a sign you are struggling financially.
- Length of credit history: The longer your credit history is, the better. Think of your credit history as your financial resume. The longer you have had good credit, the more creditors will trust you. If possible, avoid closing older accounts or applying for too many new credit accounts, and keep all your credit cards active.
- New credit: Every time you apply for new credit, lenders will pull a hard inquiry on your credit reports to verify your credit, which dings your credit slightly. Sending out multiple credit applications simultaneously can cause a negative compounding effect.
- Credit mix: Having a good mix of different types of credit accounts, such as credit cards, auto loans, student loans, and mortgages, can show lenders you know how to manage various types of credit. However, that doesn’t mean you should go crazy on applications. Make sure you apply for credit with intent.
9 Reasons Why Your Credit Score Dropped
1. High Credit Utilization
Credit utilization is a major component of your credit score. It is the second most heavily weighted factor, right behind payment history. A high credit utilization rate can negatively impact your credit score because it signals to lenders that you are maxing out your available credit, a sign you may be a higher-risk borrower. Lenders may view your credit usage as a signal that you are overextended and less able to make timely payments if you are using a large portion of your available credit. That could lead them to deny your loan application or raise interest rates on future loans to offset the risks of lending to you.
You can avoid damaging your credit score by keeping your utilization rate low. Aim for 30% or below, and pay down balances as quickly as possible each month. I typically try to keep my utilization ratio below 15% to be safe. For example, if you have 2 credit cards, one with a $5,000 credit limit and one with a $3,000 credit limit, your total available credit is $8,000. In this case, you should aim to use ~$2,300 or less at any given time to limit the negative impact on your score.
If you are having trouble keeping your utilization low, one trick you can use is to pay off your balance before the end of your billing cycle. When I studied abroad a few years ago, my credit card had a relatively low overall credit limit. So, I would pay off my balance every week or every other week instead of once a month. That way, my usage would appear lower on my credit statements.
2. Recently Closed an Account
If you recently closed a credit account, there are a few things to keep in mind in terms of how that will affect your credit score. If the account had a balance when it was closed, that could potentially hurt your score as it will get reported as debt you owe. The length of time that the account was open can also factor into your credit score. Generally speaking, longer-term accounts are better for your credit than shorter-term ones. If you close an account you have had open for a long time, that could significantly decrease the average age of your credit scores, causing your credit to drop.
Closing an account can also increase your credit utilization ratio. Let’s say you have 3 credit cards, each with a $3,000 credit limit. One card has a $1,000 balance, one has a $1,500 balance, and one has a $500 balance. Your total credit usage is $3,000, or ~33% of your overall credit limit. If you close one account, you will increase your utilization to 50% — well above the 30% financial experts recommend!
Before closing an account, weigh the pros and cons carefully. If you have a credit card with a high annual fee that you do not use, then it may be time to close the account to cut down on costs. Or, if you find yourself constantly overspending and going into debt, it may make sense to cancel the card.
3. New Mortgage, Loan, or Credit Card Application
When you apply for a loan or credit card, the lender will pull a hard inquiry on your credit reports to check your credit score. Hard inquiries can cause your score to drop by a few points temporarily. If you have multiple hard inquiries in a short period, lenders may think you are desperate for money and are more likely to default on your loans. That can make it harder to get approved for new loans and lines of credit in the future.
Hard inquiries stay on your report for 2 years but only impact your score for the first year. After 12 months, they’ll fall off your credit report and won’t affect your score any longer. On the other hand, a soft credit inquiry on your credit report has no impact on your credit. If you see a soft inquiry on one of your credit reports, all it shows is that you or another company checked your report.
Usually, if you request a credit line increase for an existing account, that may trigger a hard inquiry. One way you can attempt to bypass this is by asking your lender to pull a soft inquiry instead, though this will not always work. A few months ago, I asked one of my lenders to increase my credit limit via a soft inquiry, but they denied my request. Other times, lenders automatically increased my credit limit after a certain period of on-time payments.
We recommend spreading your new credit applications over time to lessen the impact on your credit. Additionally, you should check or monitor your credit regularly using tools like Credit Karma.
4. Late or Missed Payments
Late or missed payments can seriously damage your credit. A late payment is defined as a payment that is more than 30 days past due. A missed payment is a payment that has not been made within 60 days of the due date. If you are a couple of days late on a payment, it is probably nothing to worry about. But, once payments are more than 30 days late, card issuers will start reporting them to the credit bureaus as delinquent.
Because late and missed payments are considered negative information, these delinquencies can damage your credit score. The severity of the damage depends on how late the payments are, how much you owe, and whether you have any other negative information on your credit report.
According to FICO data, if you have a 30-day missed payment, your credit score can drop 17-37 points if you have fair credit and 63-83 points if you have good or excellent credit. The longer you miss a payment, the further your score will drop. Unfortunately, the higher your credit score is, the more room it has to fall.
If you have late or missed payments, take the necessary steps to improve your payment history rating by making all future payments on time and bringing any past-due accounts current. You may also want to consider contacting creditors to negotiate more favorable terms for repayment.
5. Decreased Credit Limit
Credit card companies determine credit limits based on your income, debt-to-income ratio, and credit score. If you frequently miss payments or make late payments, your lender may lower your credit limit. It may also be harder for you to qualify for an increase in your credit line or a new credit card.
If you are close to or at your credit limit, a decrease can put you over the edge and result in penalties from your lender, not to mention the high-interest rates you will need to pay. A lower credit limit may mean you are using a higher percentage of your available credit even if your spending remains unchanged, which lenders do not look favorably upon. It could also indicate that you are struggling to make payments or manage your debt.
If your credit scores take a hit as a result, pay close attention to your credit utilization ratio. You may need to reduce your spending to raise your score back up. Alternatively, consider transferring your balance to a 0% APR credit card that allows you to increase your credit limit and potentially pay off your debt faster.
6. Mistakes on Your Credit Reports
Mistakes in your credit reports can negatively affect your credit score and cause your credit to be lower than what you deserve. Check your credit report regularly and dispute any errors you find to ensure no inaccurate information appears in your files, such as erroneous personal data or credit accounts you do not recognize. Note that you can’t dispute certain data, such as hard inquiries from credit applications you sent out or bankruptcy you filed.
If you find any mistakes, notify the corresponding credit bureau and reporting lender. Federal law gives you the right to dispute inaccurate information at no cost. If the credit bureaus cannot confirm the legitimacy of the inquiries after launching an investigation, they are required to remove them.
If you need additional guidance on the steps you need to take to dispute the errors, make sure to go to the FTC’s website. If you were a victim of credit fraud, the FTC also help create a recovery plan for you.
7. Foreclosure or Bankruptcy
Foreclosure and bankruptcy can both hurt your credit scores. If you are facing foreclosure, you may be able to avoid some of the damage by working with your lender to try and find a way to keep your home. However, if you can’t avoid foreclosure, your credit and finances may be in trouble.
Bankruptcy will also harm your credit, but remember there are different types of bankruptcy. A Chapter 7 bankruptcy will stay on your credit report for up to 10 years and generally will have greater effect than a Chapter 13 bankruptcy, which only stays on your report for 7 seven years.
Aside from hurting your credit, either event can disqualify you from getting approved for certain types of lending programs and tools in the future. For example, mortgage lenders may be less likely to extend a loan to you if they see that you have had a foreclosure in the past.
8. Recently Paid Off a Loan
This may sound counterintuitive, but paying off an installment loan, such as a car loan or mortgage, could cause your credit score to dip slightly. That is because you will have one less credit account in your name, which affects your credit mix. In general, lenders like seeing borrowers manage different types of revolving credit and installment loans.
However, that doesn’t mean you should avoid paying off your loans. Being debt-free improves your overall financial health and allows you to focus on other financial or personal goals. It does not make sense to keep paying unnecessary interest fees to boost your credit score by a few points. Additionally, if you have a good payment history with creditors, this can help improve your score over time. That is because you are showing that you’re capable of repaying debt responsibly.
9. Identity Theft
If you don’t check your credit accounts regularly, it is possible that someone has stolen your identity and opened new accounts in your name without you knowing about it. That can seriously damage your credit score and may take some time to fix completely depending on how many accounts were opened and how much debt was incurred.
If you suspect you’ve been a victim of identity theft, you should contact the police immediately so they can begin investigating. You should also place a fraud alert on your credit file and fill out an identity theft report with the FTC. Then, you can start the process of disputing fraudulent information on your credit reports with the credit bureaus.
As you go through this process, consider freezing your credit. That will make it harder for identity thieves to keep opening accounts in your name. In any case, don’t panic as there are steps you can take to reverse some of the damage.
4 Ways to Improve Your Credit Scores
There are a few things you can do to improve your credit:
- Monitor your credit: Stay updated on your credit scores and reports so you can identify any potential problems early on. Doing so will also help you understand why your credit dipped and how to course-correct.
- Develop a budget: Designing a budget tailored to your lifestyle and sticking to it will help you keep your spending in check and prevent you from racking up more debt than you can handle. You can use an app like Mint or Personal Capital to track your spending and set expense categories. I currently use Mint and a spreadsheet to track my monthly expenses.
- Minimize debt: If you can afford it, pay off your debts as quickly as possible. The sooner they are paid off, the less of a negative impact they will have on your credit score. Additionally, avoid using credit if you can’t pay off the balance by the end of the billing cycle.
- Pay your bills on time: Always pay your balances in full and on time at the end of each billing cycle. If you’re having trouble remembering when to pay, set up automatic payments. But make sure you have money in your bank account to avoid an overdraft.
The Bottom Line
Credit scores fluctuate frequently, so there’s no need to worry or panic if you see small changes in your credit scores. However, it’s good practice to check your credit report at least once a month or once every couple of months to monitor changes. If there’s a significant drop in your credit scores, it will be much easier to identify the issue and quickly resolve it.
In the meantime, you can take steps to improve your credit scores by paying down some of your debts and making sure all of your payments are made on time going forward. While it is disappointing to see your credit score drop for any reason, remember that there are things you can do to improve your situation. With a little effort, you can get your score back up in no time at all.