Why Did My Credit Score Drop? – 5 Reasons To Check
A high credit score is a point of financial pride for many.
It demonstrates your financial prowess because you have the funds to be responsible with your debt. It also helps your finances since you pay less interest on your debts.
There’re lifestyle benefits, too. With a higher credit score, you can get better houses, cooler cars, and more exclusive forms of credit (like higher-tier credit cards).
For some, it’s simply a bragging right. “Haha, I have the highest credit score of anyone I know!”
So it can be disappointing when your credit score drops seemingly out of nowhere.
There are 5 factors that impact your credit score. Check out this article we wrote about everything credit score.
But even if you know those factors, your score could’ve dropped for a number of reasons that aren’t always obvious at first.
Keep reading to see some reasons why your credit score dropped.
1. Missing Payments
Making timely payments on all your bills is the most critical factor to keeping a good credit score.
It’s so important, in fact, that your payment history actually determines 35% of your credit score!
Bills Directly Involving Your Credit Score
Bills that directly involve your credit score at some point raise your credit with consistent monthly payments, but ding your credit if your miss them.
These are bills like
- Credit cards
- Loans
- Mortgages
Since your ability to get new credit is based directly on your credit score, you can use these to build your payment history.
Bills NOT Directly Involving Your Credit Score (Non-Debt Bills)
You can’t say the same about many other bills, though.
For example, tons of renters think they’re building credit every time they hand in their rent check on time.
That’s not the case, though, because landlords rarely (if ever) report rent payments to credit bureaus; even if they checked your credit when you applied to live there, they don’t inform credit bureaus of on-time payments.
And technically, they don’t report late or missed payments, either.
But they DO send unpaid bills to collections, which ends up on your credit report and knocks down your score.
It’s the same with other bills, like
- Phone bills
- Insurance
- Utilities
- TV
Many companies will give you a lot of time before sending your bills to collections. They will shut off your service before then, though, so you shouldn’t slack just because you don’t have debt collectors knocking on your door.
It appears the deck is stacked against you. Late payments can damage your score, but on-time payments won’t help it.
You may as well pay everything on time!
2. Credit Utilization
Revolving credit is credit that doesn’t require full payment and doesn’t have fixed payments. The most common type of revolving credit is the credit card.
Heavy reliance on revolving credit makes your score fluctuate.
Why?
For one, your credit limit is determined by your ability to pay back credit. In other words, a higher income generally gets you a higher limit. Holding a high credit balance relative to that limit is naturally more difficult to pay off, meaning the lender is bearing more risk of not getting their money back.
The other reason is heavy credit usage indicates financial distress. If you have to put everything on the card, that implies you aren’t making enough money to handle your normal purchases, let alone debt payments.
The Credit Utilization Ratio
The credit bureaus calculate a ratio called the Credit Utilization Ratio to determine your credit utilization. This ratio is simply the combined total balance on all revolving credit sources divided by your total credit limit on all those sources.
So if you had $2,000 in credit balances spread across 4 credit cards each with a $1,000 credit limit, your ratio would be 50% no matter the amount on any individual card.
Credit utilization is easy to reduce. Just pay down your cards more aggressively. A good rule of thumb is to keep utilization below 30%. We’d recommend going even lower if you have the funds to do so.
Back to our example: to reduce that 50% credit utilization ratio, you’d want to pay down your credit card balances. If you can bring your total balance across all cards below $1,200, you’d fall below 30% credit utilization and your score will move upwards.
3. Applying For More Credit
Yes, the credit world is cruel enough to penalize you for wanting to participate in it.
Whenever you apply for new credit, your prospective lender performs an action called a “hard inquiry”, which is just a formal pull of your credit history and score.
Why do you get punished for having your credit checked, though?
Most people know that timely payments and low balances help your score because they imply responsibility. The same research that found this also found that people who apply for new credit are slightly less likely to make timely payments in the future. Hard inquiries provide account for that ahead of time.
If we had to guess why that’s so, it’s because having more credit accounts increases the difficulty of paying them off ever so slightly.
But don’t worry: they adjust the effect of hard inquiries accordingly.
At first, hard inquiries will have a noticeable impact on your score. You don’t have much history, so each hard inquiry carries a lot of weight.
When you’ve built up some credit history, other factors begin to take precedence over hard inquiries. After only a few years, hard inquiries will only knock a couple points off your score.
And after 2 years, hard inquiries are erased from your credit report. You’ll notice a nice little boost in score when this happens.
Soft Inquiries
Soft inquiries happen as well. They don’t damage your credit at all.
These types of inquiries happen when:
- You check you own credit score – It would be unfair to penalize you for trying to fix or analyze your credit.
- One of you current lenders checks your credit to offer higher credit limits or other special offers – They already know your credit habits, whereas new lenders don’t.
- You apply for a prea pproval offer, leading to a soft inquiry – You aren’t formally applying for the credit yet.
- A lender sends you a pre approval/pre qualification offer – It would be unfair to penalize you for a credit check you didn’t explicitly authorize.
You can minimize hard inquiries if you take advantage of pre qualified offers, which could help your score by increasing your credit limit and diversifying your credit mix.
Just don’t get carried away with debt on your soft-inquiry cards or the credit score benefits will be rendered moot.
4. Defaulting On Your Debt
Debt default occurs when you fail to pay one or more debt payments on time.
Now, you already know that missing payments itself hurts your score. But defaults punish you on top of that.
The amount of payment failures varies from lender to lender. Some will put your debt into default if you dare to miss 1 payment. Others give you 3, 4, or even more chances before you’re in default.
Consequences of Debt Default
Once you default on your debt, your credit score will take a serious hit. Not only that, but the lender will repossess the debt collateral. If you default on a mortgage, for example, the bank will foreclose your house.
If there’s no collateral, the lender may sell the default to a collections agency, and you do not want to deal with an aggressive collections agency.
There’re a host of other potential consequences, like
- Legal issues (getting sued)
- More fees
- Bankruptcy, which can severely damage your credit score AND stay on your credit report for 7 or more years depending on the type of bankruptcy
Oh, and defaults stay on your report for 6 years, regardless of paying off the debt. Your credit score will take a long time to recover.
Debt Default Notices
All that sounds pretty scary.
Lenders don’t just put your debt into default without notifying you, though.
They’ll send you a formal notice of debt default. This notice will list how far behind you are on payments, and how much you need to pay to catch back up.
You’re given about 2 weeks to make things right, or default occurs and your credit score drops like an anvil.
Along with the constant harassment from collections and the repossession of collateral, of course.
5. Closing A Credit Account
We might have scared you a bit with the section on defaults, but closing a credit account is much more tame.
Still, you might be wondering why you’re penalized for taking actions that directly reduces your risk. After all, you’re reducing your access to debt, right? Wouldn’t that mean you’re less tempted to dig yourself into a hole of debt?
Credit Mix
Well, closing a credit account actually affects your credit mix (the amount and types of accounts you have open).
People who can successfully juggle several accounts of varying types are naturally more likely to pay on time and manage their money properly, so credit mix is important.
A Return To Credit Utilization
It also comes back to credit utilization. Closing an account could reduce your credit limit much more than your credit balance if it’s relatively unused.
Let’s say you have $2,000 spread across 4 credit cards, each one with a $2,000 limit for a total of $8,000. Your credit utilization is 25%, safely under the 30% rule of thumb.
However, one card never has more than $10 on it. You decide to close it.
Now, you have $1,990 spread across 3 credit cards with a total credit limit of $6,000, which gives you about 33% credit utilization. All of a sudden, you’re above that 30%.
Although that wasn’t your intention, the credit bureaus unfortunately see it that way. They have no reason not to.
You can’t just never use the cards you leave open, though, because of course the credit bureaus know people will do this for a credit boost and thus subtly require that you use them.
The best method would be to reduce credit usage, but maintain an insignificant balance on every card you don’t regularly use.
Credit Score Isn’t Simple
Your credit score’s got a lot of moving parts. It’s hard to keep track of everything going on.
Just when you thought you ironed out whatever was stagnating your score, something else causes it to drop again.
Make no mistake: reaching the upper echelons of credit score takes discipline and a bit of scrappiness.
But it’s the same way with everything else in life: if you want to be near the top, you have to put in the work.
Make every single payment on time without fail, use your credit cards but not excessively, only apply for new credit when you need it, hold onto a variety of debt as long as it’s manageable, and take care of any notices of default if your find yourself in that situation.
It’s simple, but it’s not always easy. However, it’s worth it.
If you stay on the wagon, you’ll see just how valuable a high credit score is when your interest rates are low, your access to new and more exclusive debt increases, and you’re finally able to qualify for that mortgage that will afford your dream home.
For more information about credit score and what affects it, take a look at this article.