Having a good credit score can open up a lot of financial options. And for people that work to rebuild their credit, making sure that number rises—and stays there—becomes an important financial habit. But credit scores tend to fluctuate fairly often. Many folks have been left wondering “why did my credit score drop for no reason?” And if you’re one of them, then read on to learn more!
There are times when that score can seem to drop for no reason. If this has happened to you, you might have asked yourself, What’s going on? What did I do wrong? You pay the same bills. You have the same number of loans. And you’re working hard to be continually responsible with your credit cards. But still, your credit score is changing—and not in a good way.
Although a credit score drop can seem to come out of nowhere, many factors can affect it. In this blog, we’ll take a closer look at your credit score and the financial elements that make it up. Then, we’ll show you what can cause your credit score to drop and how to put it back on the right track.
Where Does My Credit Score Come From?
When it comes to credit scores, we are taught one fundamental lesson: A good credit score is good, and a bad credit score is bad. And for most of us, that’s where our understanding ends. Many people don’t know where their credit score comes from or even what it means.
Your credit score is a rating that shows the level of the financial risk involved with loaning you money. This score not only affects loans but also lines of credit—like the kind you would get with a credit card. Your credit score tells potential lenders and creditors how likely you are to pay back the money you borrow from them.
Your credit score is determined by five major factors, listed below with the percentage of their impact on your rating:
Payment History (35%)
Your payment history is the record of your payments to the people and businesses that you owe money. In addition, lenders want to know if you’re going to repay their loan, making your payment history the most crucial part of your credit score. This is why every path to rebuilding credit and maintaining a good score starts with paying bills on time.
Credit Utilization (30%)
Your credit utilization ratio is a number that details available credit you are using at a given time. For example, let’s say you have a credit card with a $500 limit. At the end of the month, your balance is $125. That would mean that your credit utilization ratio is 25%. A credit utilization ratio of 30% or below will do wonders for your credit score.
Credit History (15%)
Long credit history is an excellent way to show creditors that you are trustworthy and likely to continue being so. In addition, a long credit history is evidence of responsible credit management over a long period.
New Credit (10%)
Opening several new accounts in a short period can affect your credit score. This is because it may look to a lender that you are in a bad financial situation.
Credit Mix (10%)
Your credit mix is the variety of credit accounts you have, which tells creditors about your ability to repay debts. In addition, having a variety of accounts can show that you can manage a new loan or line of credit.
These five factors are weighted and calculated by the companies that determine your credit score: the credit bureaus.
Credit Bureaus and Your Credit Score
Credit bureaus provide the banks, lending institutions, and individuals with information about consumer spending trends and habits. The three major credit bureaus reporting on consumers in the United States are Experian, Equifax, and TransUnion.
That information that credit bureaus use comes from companies that you do business with. So, for example, if you are late or miss a payment on a utility bill or credit card balance, it can be reported as a delinquent act and negatively affect your credit score. And yes, this is the time where we remind you again to pay those bills on time!
The details on your payment history and those of the other factors are compiled into files called credit reports. These reports are then made available to anyone looking for financial information about you. If you have ever rented a home, bought a vehicle, or applied for a credit card, you most likely have a credit report.
evaluate all of your activity and calculate your credit score—a three-digit number ranging from 300-850:
- 800-850: Excellent Credit
- 740-799: Very Good Credit
- 670-739: Good Credit
- 699-580: Fair Credit
- 300-579: Bad/Poor Credit
Getting low interest and reasonable loan terms can be easy for people with good credit. With a history of paying bills on time, these individuals are likely to continue making payments. On the other hand, a person with bad credit may be given a high-interest loan by a lender. This is because a lender is more likely to provide them with the loan to increase their chances of repayment.
Because of the vast difference between good or bad credit options, having an accurate credit score is very important. It could make the difference in getting the loan or credit line you need in making many of life’s dreams come true.
Your Credit Score: Know Your Rights
One of the essential facts about your credit score is that it is available to you whenever you want to review it. Thanks to federal laws enacted under the Fair Credit Reporting Act, your credit report and score are available to you through any major credit bureaus. Additionally, credit reports are available on several websites (like creditsesame.com) that provide information to consumers about monitoring or repairing their credit.
Reasons Why Your Credit Score Dropped
So, now that you know what makes up your credit score let’s look at some of the primary reasons your credit score could drop without warning.
Credit Limit is Reduced
It may seem odd that having less credit would be something that would cause your credit score to drop. However, when your credit limit is reduced, your credit utilization will rise faster.
Let’s take another look at that credit with the $500 limit. Remember that $125 balance and 25% credit utilization ratio? If that card’s credit limit is reduced to $400, that same balance will give you a 31% utilization rate.
If you notice a change in your credit score after a limit reduction, take a look at your utilization rate. You may need to reduce your credit card spending to improve your scores. Also, you may want to consider opening up a balance transfer credit card. Adding another credit card will increase your available credit, which will, in turn, lower your credit utilization ratio. And if you can find a card with a 0% introductory rate, you could even pay off the balance faster. And no matter what your credit score is, getting out of debt quickly should always be a top priority.
Paying Off A Loan
If you thought that your credit score dropping by having less credit was confusing, consider this fact: paying off a loan can lower your credit score, too!
When you pay off a loan, you essentially get rid of one of your credit accounts. That means that your credit mix—that variety of accounts can prove you do well with managing your debt. But, on the other hand, one less loan means one more minor piece of obligation to work, so your credit mix decreases. And since you’ve weakened an aspect of your credit, your overall credit score can take a dip.
For anyone working hard to keep their credit score up, a drop of even a few points can be very frustrating. But a slightly weaker credit score is worth the elimination of a bill. And in the long run, a good credit mix weighs far less on your overall score than things like payment history and outstanding balances. In time, your good financial habits will keep that credit score rising.
Closing a Credit Card
Just like paying off a loan, closing a credit card is another way that favorable action can hurt your credit score. Not only does closing a credit card get rid of an account (which affects your credit mix), it will also decrease your available credit. If you don’t reduce your spending, that new lack of recognition could create a high credit utilization ratio.
If the credit card was an older account, closing it will also affect the average length of your credit history, showing lenders that you can manage credit well over time. While completing a statement that you can afford is a perfect thing, available credit can come in handy under many unexpected circumstances. For example, there may be a surprise expense, like an unexpected repair or an emergency medical expense, where a credit line may help you finance the solution you need. If you can, consider holding onto the account.
Hard Inquiries On Your Credit Report
As we mentioned earlier, potential lenders and creditors use credit reports to evaluate your creditworthiness. This usage is called a credit inquiry.
Credit inquiries can hit a credit report in two ways: soft questions and complex queries.
Soft inquiries are glances at your report that have nothing to do with approving you for any loan or financing. These types of inquiries are mostly done during background or identity checks.
Conversely, when a financial company reviews your report with the intent to make a lending decision, this is known as a hard inquiry. Hard inquiries are usually made when financing a significant purchase, like a car or a home or applying for credit cards. This impact will occur even if you are approved for the loan that triggered the hard inquiry.
And unfortunately, hard inquiries can temporarily lower your credit score.
Hard inquiries can stay on your report for up to two years. However, their impact will lessen over time, especially if you continue to keep practicing good habits that don’t negatively impact your credit report.
Dispute Credit Report Errors
Sometimes the reason you see a credit score drop on your report can be a simple one: human errors and technical glitches on your credit report.
If your credit score changes without any unusual activity on your part, a look at your report may help you find the cause. Often, credit reports can have information on your account that is either outdated or incorrect. A study of the credit reporting industry, conducted by the Federal Trade Commission (FTC), found 20% of consumers (or one in every five) have at least one error across their credit reports.
It’s important to note that the three major credit bureaus—Equifax, Experian, and TransUnion—each produce separate credit reports and credit scores for every consumer. And although they are accessing the same information about you, they each have their standards and practices. Considering the vast amount of data these companies compile for millions of people, errors are almost unavoidable.
There are a ton of errors that can show up on your credit report. For example, accounts that are settled or closed can appear to be opened or have balances that can affect your credit utilization. Payments that are on time can be listed as late or even delinquent. There have even been cases where people sharing the same or similar names have had their information switched or misplaced.
Fortunately, the process for disputing credit errors has never been more straightforward. Each credit bureau can receive disputes online through each of its websites. Additionally, many credit monitoring apps and websites can send arguments to the bureaus for you. Conflicts typically take about 30 days to resolve. You can dispute errors on your report at any time, for free.
Sometimes, the reason that your credit score has dropped isn’t so easy to fix. Let’s take a look at the most concerning reason for a drop in your credit score: You could be the victim of identity theft.
Identity theft is the act of someone using your personal information without your permission. This information could include your name and address, credit card, bank account, or medical insurance information. Identity theft is quickly becoming one of the most common crimes in America today. According to the FTC, instances of identity theft doubled between 2019 and 2020.
Some common ways that identity theft can happen:
– A lost wallet or purse containing your ID, credit, and debit cards can be found by someone else and used to make purchases.
– Phone scammers pose as government agencies or credit card companies calling to request sensitive information like your social security and bank account numbers.
– Information is stolen from an unsecured account you may have online. This is where today’s identity thieves can do a lot of damage in a concise amount of time. With passwords to the correct accounts, hackers can assume separate identities and wipe numerous bank accounts within a matter of hours.
No matter who it happens to, Identity theft is a serious crime.
If you discover that an impostor uses your identity, know that you can decrease or even reverse some of the negative impacts. The key is taking quick action.
How To Handle Identity Theft
The first thing to do when you discover identity theft is to report it. Contact the Federal Trade Commission at 877-438-4338 or by visiting IdentityTheft.gov. Filing an instance of identity theft with the FTC will help preserve your rights and clear fraudulent items on your credit report.
You can also add a fraud alert to your credit report with each of the major credit bureaus. Unlike a credit freeze that disables any credit inquiries, a fraud alert is a warning set up to alert you when your credit report is being accessed. When a fraud alert is posted on a credit report, potential lenders are required to contact you and verify your identity. If you receive a call from a lender you don’t know, that can tip you off that someone is trying to use your identity.
Identity thieves can be tricky. Because of this fact, many experts suggest regular viewings of your credit report. Staying vigilant, watching for changes, and acting fast is the best way to stop the effects of identity theft as early as possible.
Discovering a credit score drop can be an unpleasant surprise. But, remember that for every issue that surrounds your credit score, you have the power to make a positive impact. All that it takes is for you to make your financial health an essential aspect of your life. Think about protecting your credit score the same way you would protect your family, home, or prized possessions. Would you leave your home and not lock your door? The same should go for your credit.
That kind of dedication will lead you to not only watch out for your credit score but also learn how to protect it.
To learn more about credit scores, like why your credit score may drop after your balance decreased, check out the CreditNinja Dojo!