Credit scores are calculated using a specific, clearly defined credit scoring model. So while it may appear your score dropped for no reason, it is never random. Something triggered it even though it might not be immediately obvious to you.
I will cover 10 possible reasons why your score may seem to drop without cause.
1. Missed or Late Payment
Your payment history and credit history is the single most important factor in credit score calculation. The FICO score makes up more than a third of your score’s calculation.
A missed payment can drop your score by dozens of points. Maybe you missed it after accidentally deleting an email notice or statement. Maybe it is a new credit account whose payments you are not accustomed to.
If you are just a few days late, the delay is unlikely to register on your credit report. Once it surpasses that crucial 30-day threshold though, lenders will report it to credit bureaus as delinquent.
How far your credit score drops will depend on how many days you have missed the payment. A 90-day missed payment will have a greater negative impact on your score than a 30-day missed payment. Also, the higher your credit score, the larger the drop will be.
Solution: Make the missed payments. How soon your score bounces back depends on your credit history and your response after missing the payment. The faster you get back on track, the sooner your score will start climbing back up.
2. You Recently Applied for a New Credit Card, Loan, or Mortgage
If you recently applied for a mortgage, loan, or credit card, the lender made a hard inquiry by pulling your credit report for a credit check. A hard inquiry (or hard pull) occurs when a lender reviews your credit report to see if you are eligible for a loan or a credit limit.
Hard credit checks will lead to a lower credit score albeit temporarily.
Lenders judge opening multiple accounts as potentially risky credit behavior.
Solution: Shopping for the best deal is actually a good thing which is why credit scoring companies will group inquiries done within a 30-day window as a single credit inquiry. So if you want to shop for a good deal, do so within a short time to avoid inadvertently hurting your credit score.
Note that hard inquiries are different from soft inquiries. Soft inquiries do not have any impact on your credit score. These occur when you or a company checks your report but not for a lending decision. It is usually for credit monitoring or background checks. Soft inquiries are only visible to you.
3. Increase in Credit Utilization
Credit cards are a convenient mechanism for making purchases. However, a large purchase could leave a large credit card balance which will raise your credit utilization ratio. Credit utilization is what you owe on your credit card as a proportion of your card’s limit. It affects your credit score.
The Consumer Financial Protection Bureau recommends you maintain a credit utilization ratio of no more than 30%. The lower, the better. (At Digital Honey, we generally recommend less than 10 per cent.) A low credit utilization shows potential lenders you are a responsible borrower and are more likely to repay your credit card debt easily and quickly.
A change in the amount you owe can cause a significant deterioration in your score. Take time to look at your credit card purchases in the recent past.
If you have charged your cards more than usual perhaps with a big-ticket purchase (such as a family vacation or a pricey electronic), your utilization has grown, and with that comes a negative impact on your credit score.
Solution: If you have had a large purchase recently, work on paying it in full before the current billing cycle ends. Pay down the balances until you are back to utilizing a more acceptable proportion of your credit.
Alternatively, request for a higher credit limit. Find out if the lender can raise your limit without a hard inquiry.
4. Your Credit Limit Decreased
Your credit card issuer may decrease your limit without necessarily notifying you beforehand. This may be in response to something alarming on your credit report, a decline in your credit scores (hence a self-fulfilling prophecy of sorts), or due to reduced transaction activity.
When your credit limit decreases without a corresponding decrease in your balances, you will have a higher credit utilization ratio. A higher credit utilization is a negative mark and lowers your score.
Perhaps you ordinarily spend $2,000 of your $8,000 credit limit. That is a 25 percent credit utilization rate. But if your credit limit drops to $4,000, your utilization instantly jumps to 50 percent.
If your spending has not changed but your limit has been revised downwards, your utilization will go up and therefore negatively impact your credit score.
Solution: Reduce your spending to bring credit utilization back under 30 percent.
5. You Closed a Credit Card
Tread cautiously before you close a credit card you no longer use. When you pay off and close a credit card account, especially an old one, your score could be negatively affected for two reasons.
First, it reduces the total credit limit available to you. Second, when you close a credit card account, the average age of your credit history and payment history is shortened, and the average age of your accounts falls. At least 10 percent of your FICO score is based on how old your credit accounts are.
Both reasons would have an impact on your credit utilization ratio and therefore have a negative effect on your credit score. Fortunately, this decline is usually temporary and you should eventually bounce back from the initial fluctuation.
Solution: Before you close a credit card account because it has steep annual fees, talk to the card company and confirm whether you can downgrade to a card with zero annual fees. This could allow you to preserve your credit line while getting a card that is better suited to your needs.
Note: Whereas you can give a credit card company instructions to close your account, some will close your account without notifying you. The Equal Credit Opportunity Act gives creditors the power to close card accounts due to delinquency, default, or inactivity without notice.
For any other reason for account closure, the company has to give you 30 days’ notice which means you may have a closed account that you are not aware of.
6. You Paid Off a Loan
Did you recently pay off a student loan, car loan, personal loan, mortgage, or other type of installment loan? Installment loans have fixed payment schedules and terms. Paying off an installment loan may cause your credit score to drop. Shocking isn’t it? Well, blame the algorithm.
You see, each different type of credit product that makes it to your credit report increases the diversity of your credit mix. You need a healthy mix of installment loans (like an auto loan and a mortgage) and revolving credit (such as credit cards).
Your credit mix is a significant contributor to your score (10 percent of a FICO score). It is a measure of how good you are as a borrower with different categories of debt. So if you pay off your only installment loan, it would diminish your credit diversity.
Solution: Probably none? Less debt is good for your overall financial health and the price of losing a few credit score points is one that is well worth it. The best you can do is strive to maintain an excellent record for the credit types of your existing credit accounts.
7. Mistake on Your Credit Reports
The points I have covered so far assume that your credit score has dropped due to accurate data finding its way to your credit report. But neither credit reporting companies like Experian nor the lenders who share your information with them are infallible.
In fact, the Consumer Financial Protection Bureau says credit report errors are among the main problems it deals with on a daily basis. It has even published a list of the most common errors you are likely to run into.
Solution: Go through your credit report meticulously and identify any item that seems off. If you pick out an erroneous entry, you reserve the right to dispute it with the reporting creditor and credit bureaus. They are required to investigate the mistake for free and correct any errors identified promptly.
8. You Were the Victim of Identity Theft
We often think of ourselves as a drop in the sea of humanity. The thought that someone out there could go out of their way to target you for identity theft always feels alien. “It happens to the one percent but surely not me!” Sadly, anyone can be a target of identity theft.
Fraudsters may open one or more credit accounts under your name. They have no interest in protecting your credit score so they are more likely to max out whatever available credit limit they can find.
Solution: Keep an eye on new credit accounts or addresses. You can reverse the damage identity theft causes to your credit score. As soon as you are aware of the identity theft, contact at least one major credit bureau and place a fraud alert on your credit file.
For instance, if you notify Experian, the other two bureaus will be notified automatically.
Next, file an identity theft report at the FTC’s IdentityTheft.gov. This report would be an important basis for disputing your credit report.
If the fraud alert is not enough to block the identity thieves, consider the drastic step of a credit freeze. This would make it harder for the thieves to open new accounts in your name.
9. You’ve Experienced a Major Event Such as Foreclosure or Bankruptcy
Derogatory items such as bankruptcy, foreclosure, collection, charge-off, and tax liens will have a negative impact on your credit score. It may be several weeks or even months before they show up on your credit report. But when they do, the impact is substantial.
Derogatory items remain on your credit report for anywhere between 7 and 10 years.
Solution: A derogatory mark’s impact on your credit score declines over time as long as you adhere to good credit behavior. You could get a derogatory mark off your credit report if you can confirm it is erroneous. All you need to do is contact Experian or the relevant credit bureau, and dispute it.
10. Something Was Recorded on Your Credit Report
Think about your payments and bills over the last few months. Have you missed paying a bill? Did you miss a credit card payment? Missed payments are usually not reported to the credit reference bureaus until they are 30 days late or more.
Your score will not change until you breach that 30-day window is breached. A late payment will certainly hurt your score but a delinquency payment (payment that is 60, 90, or even 180 days) will have a devastating effect.
Solution: Take action depending on what the new item was.
Should You Worry About Changes in Your Credit Score?
Small fluctuations in your good credit score are normal and nothing to worry about. That being said, it would be prudent that you check your credit report at least once a month to catch these changes quickly.
You would want to assess whether the change is something that you can remedy and requires your attention (such as a missed payment) or something you can ignore (like a paid-off student loan).
Take note of large drops in your credit score as these could be indicative of a major credit event making it to your report. By taking the time to look closer at your report, you may uncover something that influenced your score but that you were not aware of.
There is plenty of information on your credit report and it is quite possible you may miss something. Read the report carefully and you just might dig out the clues of what caused your credit score to drop.