By Michael Grace | American Express Credit Intel Freelance Contributor
6 Min Read | January 29, 2021 in Credit
A credit score can change from month to month, week to week, or day to day as lenders supply new information to credit bureaus. Fluctuations are typical. Your credit score may drop for several reasons – some likely obvious and others less so. Let’s explore both to help better understand what makes your credit score go down.
First, knowing how your credit score is generated can help you understand why or when that three-digit number – used by lenders to help predict your riskiness as a borrower – drops.
FICO, whose credit scoring model is used most often by lenders, uses five criteria in its formula to compute a borrower’s credit score. Each criterion carries a certain weight:
VantageScore, the other major player in credit scoring, explains its scoring model by levels of influence:
When one or more of these areas are adversely affected, your credit score is likely to drop. How much and for how long your credit score remains lower likely will depend on the nature of the issue and how it reflects against your recent and long-term credit history.
Experts point to the following as likely reasons a credit score is lowered.
1. Missing a monthly payment. Experts agree that paying your bills on time has the greatest effect on your credit score. Based on sample credit score examples from FICO, a person with very good or excellent credit will likely see a bigger drop in their score for a missed payment than someone with a fair credit score.1 That’s because for a person who pays their bills on time, missing one is considered more significant than for a person whose credit score already reflects past behavior of missed payments. But regardless of your credit score beforehand, the longer the period of missed payments, the greater the drop. Simply put, a 30-day missed payment will likely have less impact than a 90-day missed payment.
2. Credit utilization ratio changes. Credit utilization ratio refers mainly to how much money you owe compared with how much you’re allowed to borrow. If you have a $10,000 credit limit and carry a $2,500 balance, then your utilization is 25%. Experts suggest keeping your credit utilization ratio to no more than 30%. Carrying a balance that pushes the upper boundary of your credit limit – perhaps you used your credit card for a big purchase or opened a loan – increases your credit utilization, which, in turn, can lower your credit score.
3. You closed a credit card account. What a relief to pay off that credit card balance, right? Right, but many experts advise keeping that account open. Closing it may reduce the overall length of your credit history, which makes up 15% of your FICO score. And with a smaller total credit limit, your credit utilization rate could rise.
4. You paid off a major loan. This may seem counterintuitive: Paying off installment debt like a car loan, student loan, or mortgage boosts your overall financial health. But it may also lower your credit score for the same reasons explained in No. 3. Your credit mix and credit utilization also change. However, the impact to your credit score will likely be small, so when you’re ready to pay off a major loan, consider doing so. Otherwise, you’ll pay extra interest charges just to keep your credit score a few points higher.
5. You recently applied for new credit. When you apply for a new credit card, the card issuer will pull your credit report to see your history and assess your creditworthiness. Lenders do the same when you apply for a mortgage or a car loan. Such a “hard inquiry” can lower your credit score, but generally factors into your credit score for only one year. Of note, multiple hard inquiries within a certain time period for a home or auto loan are generally counted as one inquiry.
It might seem as if your credit score dropped for no reason. But something probably did change – whether the direct result of a person’s actions or an event beyond their control. Here are some possibilities:
1. A decrease in credit limit. A lender may lower a person’s credit limit if they use their credit card too much or not enough, their credit report suggests they overextended their lines of credit, or the lender is trying to lessen its exposure during an economic downturn. A decrease in credit limit could create an increase in a person’s credit utilization ratio, which, in turn, may lower their credit score.
2. An account goes to collections. Generally, if a person misses three or more monthly payments in a row, a creditor may send their remaining balance to a collection agency to get paid.2 Adding a collections agency to a credit history already lowered due to missed payments is less than desirable. The more recently a collection appears on a person’s credit report, the greater it may affect their credit score. Collections involve outstanding debt, so it is possible that certain items that don’t ordinarily appear on a credit report will appear once a collection agency becomes involved. Examples include unpaid parking tickets, utility bills, cell phone bills, and child support.
3. Identity theft. Nearly 60 million Americans have experienced identity theft in one form or another, according to a 2018 online survey conducted by The Harris Poll. Criminals may run up a person’s credit card balances, which then adversely affects their credit utilization ratio. Many credit card issuers offer fraud protection and zero liability to protect their cardholders.
Certain factors, such as missing a monthly payment or a high credit utilization ratio, play a bigger role than others in lowering a person’s credit score. Understanding those factors could help you keep your credit score from dropping, as well as help increase your creditworthiness in the eyes of lenders.