I share a lot of tips around here about how to build your credit history, improve your credit rating, and pay off your credit card debts. And in almost every case, one of the first pieces of advice I give is to sign up with a credit score monitoring service like Credit Karma or Free Credit Report. After all, how can you maintain a healthy credit score if you have no idea what your credit score actually is?
But let’s say you took my advice and decided to check your credit report. Now, let’s say you didn’t like what you saw. It’s clear there’s been a significant credit score drop since the last time you checked in. But what exactly happened to cause this drop?
Was it something you did (like missing credit card payments), or something you didn’t do (like paying an outstanding medical bill), or something that was done to you (like identity theft)? Well, it could be any and all of these things.
So to help you get to the bottom of your credit score drop, I’ve compiled eight of the most common reasons that credit scores drop. But before I get to our list of reasons, let’s take a quick look at credit scores and how they work.
This should provide you with a better understanding of the events that can cause credit scores to drop and the reasons these events are reflected in your credit report.
A Quick Overview of Credit Scores
Your credit scores are figures used to determine your suitability to receive loans and your likely ability to repay these loans. Loans may include lines of credit, auto loans, home mortgages, small business loans, and more.
In each of these cases, your prospective lender will evaluate your credit scores to determine your fitness to receive the loan in question. Based on this fitness, you may or may not be approved to receive the loan for which you have applied.
If your credit score renders you fit to receive the loan in question, the strength of your credit score will determine some of the lending and repayment terms attached to your loan such as your interest rate on repayment, your overall credit limit, and certain fees.
In the simplest of terms, the higher your credit scores, the better your chances of approval are for a credit line or loan; and the higher your credit scores, the more favorable the terms are that you’re likely to receive from a lender.
So who’s responsible for calculating your credit scores? Well, most credit reports include scores from a few leading credit reporting agencies.
Credit Reporting Agencies
You may have noticed that you have a few different credit scores on your credit report. The most common credit score is your FICO score. The term FICO score is often used interchangeably with credit score. FICO has been the leading credit scoring agency since 1956.
However, the three major credit bureaus–Experian, Transunion, and Equifax–teamed up in 2006 to create an alternative measure called VantageScore. The primary difference between your FICO score and VantageScore is that the latter places a heavier emphasis on payment history and credit history in calculating your score whereas FICO weights current factors more heavily in its calculation.
Regardless of which score you refer to, chances are that your credit scores will all fall in a similar range to one another, presuming that the information reported to each agency is accurate and consistent. But what are credit score ranges, and what do they actually mean?
The Credit Score Range
FICO and VantageScore use the same scale to calculate credit scores, which will fall between 300 and 850. Your score can fall anywhere between “bad”, on the lower end, and “excellent” on the higher end with several other designations in between.
The designation given to your credit score is important. This one word descriptor can carry a lot of weight when it comes to opening a new credit card account, applying for a car loan or seeking pre-approval for a home loan.
Below is a breakdown of the typical credit score ranges and the common credit rating designations connected with each of these ranges:
- Bad Credit Score: 300-549
- Poor Credit Score: 550-619
- Fair Credit Score: 620-679
- Good Credit Score: 680-739
- Excellent Credit Score: 740-850
850 is considered a perfect credit score.
In most cases, lenders will be seeking borrowers with “Excellent” or “Good” credit. Even “Good” credit may limit some of your borrowing opportunities, particularly if your score falls on the lower end of the “Good” range.
Borrowers with “Bad”, “Poor”, or “Fair” credit risk being rejected for many borrowing opportunities or receiving borrowing opportunities with onerous repayment terms such as extremely high-interest rates and various user fees.
So now that I know how these credit scores are categorized, what do they actually mean? What factors really go into determining these scores?
The Five Factors of Credit Scoring
- Payment History: By most accounts, the number one factor in shaping your credit score is your payment history. High credit scores typically reflect a history of on-time payments whereas lower credit scores may reflect a history of late payment, missed payments, delinquent accounts, or accounts which have been sent to collections.
- Credit Utilization: Another major factor impacting your credit scores is your credit utilization ratio. This is based on the amount of debt owed relative to your overall credit limit. The lower your credit utilization ratio is, the higher your score is likely to be. Experts suggest that an ideal utilization ratio is 30% or less. Anything higher than this rate can lower your credit scores.
- Length of Credit History: Credit bureaus like to see that you have a history of on time payments, but that means you actually have to begin building that history through real credit usage. The longer your history of on time payments is, the more likely lenders are to view you as a responsible borrower. In the simplest terms, your credit history generally begins with the very first credit card or borrower account that you still have open today. Pro tip: That means you never want to close old accounts, even those you never use. They are a testament to your long and healthy credit history.
- New Credit: Any time you apply for a personal loan, sign up for a new credit card offer, or seek an auto loan, the national credit bureaus receive what is called a hard inquiry. These neutral inquiries can result in a temporarily fluctuating credit score, and even a slight drop.
- Credit Mix: The variety of credit accounts you carry can also improve your credit scores. Credit bureaus grant borrowers a higher rating for demonstrating that they can responsibly manage a variety of account types. Successfully managing credit cards, auto loans and mortgage payments, for instance, can denote a responsible borrower with a diverse credit mix. This would likely result in a higher score.
One noteworthy fact, in consideration of the five factors cited above, is that all of these are subject to change. You can make improvements to your credit score by addressing some of these areas individually.
- For instance, taking steps to pay down your credit card debt more aggressively can absolutely reduce your credit utilization ratio and result in improvements in your credit scores.
- Likewise, the negative impact of a hard inquiry will only last for a short duration. You are likely to see a quick rebound from this drop provided you manage the resulting credit account or loan responsibly.
- And it goes without saying that the length of your credit history will just naturally improve over time.
But raising your scores isn’t necessarily as fast or easy if you’ve had some negative marks in your payment history.
How Long Does It Take to Improve Your Credit Scores?
As we noted above, it may be possible to improve your credit scores with a few quick wins. For instance, you may be able to improve your debt utilization ratio simply by reaching out to your credit card issuers and requesting a raise in your total credit limit. This alone could bring your score up a few points in no time.
But what if you have negative reports on your credit score?
This factor is extremely consequential. Negative reports can remain visible on your credit report for many years. Even as you make other strides like paying down debts, improving your utilization ratio, and diversifying your credit mix, negative reports can follow you into a variety of financial arrangements.
Capital One indicates that you can expect negative information regarding recurrent late payments, delinquent accounts, and accounts in collections to remain on your credit report for as long as seven years. That means this information will be visible to potential lenders when you apply for future credit cards on personal loans.
Yet more severe negative reports can remain visible on your credit report for even longer. If you’ve been on the receiving end of a lawsuit or legal judgment, or you’ve filed for bankruptcy, this is information that may be visible in your credit report for as long as ten years or more.
If this describes your situation, patience will be an important virtue as you work to rehabilitate your credit score.
But first things first. If you’re checking into your credit report for the first time in a while and it appears that your credit score has dropped, it’s important to act quickly. However, in order to do so, you must first determine the cause of your credit card drop.
8 Potential Reasons for Your Credit Score Drop
There are several reasons why your credit score might have gone down.
Your credit scores are dependent on key factors including payment history, credit card usage, and overall debt. So if you do see a drop in your credit score, there are a number of common causes that you should consider.
And do also consider that there could be multiple overlapping causes at the root of your declining credit score.
With that in mind, here are eight possible causes for a drop in credit score.
1. Late or Missed payments
This is the single most important factor in determining your FICO credit score. As such, late or missed payments are among the most common explanations for a drop in your credit score. A history of late or missed payments on loans, credit cards, or other bills can even lead to long term damage to your credit score.
And as I discussed in the section above, this is exactly the kind of negative report that could stick with you for a few years. Experian warns that “Records of your late and missed payments remain in your credit file for seven years, while positive payment history on an open account can stay on file indefinitely (or 10 years if the account is closed in good standing).
Be sure to make all your payments on time so the record of your strong credit behavior bolsters your score for years to come.”
If you’ve noticed a recent drop in your credit score, the first step is to check up on the various accounts for which you make monthly payments. Has anything fallen through the cracks? Or perhaps there’s even an old bill you’ve simply forgotten about.
This is an instance in which having a credit monitoring service can be invaluable. View your credit report and look for any accounts, old or current, which may not be in good standing.
Take immediate steps to get these accounts current. Alternatively, if you believe the negative reports indicating late payments are incorrect, take steps to dispute these marks through your credit monitoring service.
2. High Credit Card Utilization Rate
Another reason you might have noticed a sudden drop in your credit score is because your credit utilization ratio has exceeded the recommended amount. Have you used a credit card account to make a large purchase recently? Or have you allowed balances and interest payments to accumulate on a number of credit card accounts?
It’s possible that recent purchases or spending habits have pushed your credit utilization rate beyond the ideal threshold of 30%. You may be able to make some quick improvements to your credit score by reaching out to your credit issuer and requesting a credit limit increase. And of course, nothing helps more than paying down your debts entirely.
3. New Credit Card Applications and Hard Inquiries
As noted above, new credit card or loan applications automatically result in hard inquiries. These inquiries are reported to the national credit bureaus and will usually result in a credit score drop. If you are monitoring your credit reports regularly, you will likely see this drop occur.
However, as long as you honor the conditions of your new credit card account or loan, as well as all existing credit cards and revolving credit accounts, you will also see the negative impact from this hard inquiry quickly subside. Your credit score will typically make a quick recovery from this type of hard inquiry.
4. Recently Closed Older Accounts
One reason you might see an unexpected drop in your credit score is because you’ve recently closed out an older account or two. There are a few reasons why this might result in a lower score. If you recall, length of credit history is an important factor in determining your credit score.
Closing old credit accounts–those which reflect the true length of your credit history–can cause your credit history to appear less mature. This, in turn, can hurt your credit score.
Likewise, with every credit card you close, you shrink your overall credit limit, which consequently raises your credit utilization rate. From that perspective, there are few things more valuable than an old credit card account with a zero balance.
If you’ve noticed a recent decline in your credit score, it’s possible a recent account closing is responsible for the drop. This is why I advise, once again, to keep your balances low but your credit card accounts open at all times.
5. Increase in Overall Debt
A credit score dropping may be an indication that your credit bureau is concerned about the total sum of your debt. Have you taken on more debt recently, either by making major purchases on your credit card, taking out an expensive auto loan, or by applying for and receiving a large personal loan.
While these events would not likely hurt your credit score by themselves, each could lead to a credit score decline when piled on top of existing debts. If your total debt has reached the point that lenders view you as financially stretched, and as a lending risk, this would likely be reflected in your credit score.
6. Loan or Credit Debt Default
If you’ve noticed a particularly large drop in your credit score, it’s possible it may have been caused by a failure to pay your loans or credit debts even after repeated attempts at internal collection. If you fail to make several payments in a row and fail to respond to efforts to bring your account into good standing, you may default on your loan or debt.
This would have a very damaging impact on your credit score, including a negative mark that would likely be visible on your report for the seven year duration noted above. Of course, defaulting on a loan will usually be preceded by numerous attempts at settling your debt. You would likely have received multiple mailers, emails, and/or phone calls directed to that end.
So if a defaulted account comes as a surprise to you, it’s important that you investigate the matter further. Is this the result of an old and forgotten debt? Was your issuer unable to reach you due to a clerical error? Or is the defaulted account the result of banking error or identity theft?
Whatever the cause, make sure you get to the bottom of it as soon as possible. It could take some time to repair the damage from a loan default.
7. Accounts in Collections
When a loan goes into default, or you fail to pay your credit debts even after repeated efforts at outreach, your account is sold to a collection agency. At this point, the collection agency will undertake efforts to recover the sum you owe. All of this is reported to the national credit bureaus and would have a negative impact on your credit score.
Whether you have unpaid medical debt, long overdue library books, or lapsed membership dues for a gym you never go to, having your account sold to a collection agency is bad news. And again, this is the kind of bad news that sticks around on your credit report for years.
This is another event you want to jump on as soon as possible, especially if you believe your account has been sold to collections erroneously. In most cases, you have a period of 30 to 60 days to respond to the first claim made by a collection agency.
If you believe a collection agency is pursuing you without grounds, respond by disputing the debt and follow up by disputing the debt to all three national credit bureaus through your credit monitoring service.
8. Errors or Fraud on Your Credit Report
If your credit score has dropped suddenly and without any apparent explanation, it is possible that you have been the victim of either a reporting error or an act of fraud. Particularly in the case of the latter, if a bad actor has used your personal information to create credit card accounts, spend frivolously, then leave bills unpaid, it could take you months to realize this has occurred.
By then, it’s already possible that your credit score has taken a hit. As Experian notes that “If something in your report is inaccurate, it could be a result of a lender accidentally reporting the wrong information. It could also be a sign that you have fallen victim to identity fraud.
You have the right to dispute information you don’t recognize or believe is potentially fraudulent. If you see something you believe is inaccurate, dispute the information with all three credit bureaus as soon as possible.”
This underscores the importance, as I have stressed throughout, of remaining on top of your credit report. Make sure you are regularly monitoring your credit scores. This not only gives you a chance to move quickly when something doesn’t look right, but it can also motivate you to take steps toward raising your credit scores every single day.
I’ve mentioned the importance of building a strong length of credit history. Some experts say this factor accounts for 15% of your overall credit score. So the best way to start building your history is to start young. That’s why so many first-time credit card holders are in college.
But just as this fast access to credit means opportunity, it also carries a few very real risks.