It’s essential to stay updated on your credit score. Knowing your current credit score can help you make adjustments to your finances. Higher credit scores can help you get a fast qualification and affordable loan terms. But what if your credit score goes up and down? Learn about the credit score algorithm and how you can limit credit score fluctuation.
What Are Credit Scores?
A credit score is a three-digit numerical representation of your financial history. Individuals over the age of eighteen can apply for credit lines and loans to develop a credit score. The management of financial accounts will determine a person’s credit score.
Before creating the credit score in 1989, the three credit bureaus had tried to find a way to make lending decisions easier. Equifax hired the Fair Isaac Corporation (FICO) to help create a standardized credit scoring system, and the rest is history.
What Are Credit Bureaus?
A credit bureau is a data collecting agency. Creditors report information to credit bureaus, who then compile a credit history based on your financial activity. That information is also provided to creditors in the form of a credit report when you apply for a loan or credit line.
There are three credit bureaus: Equifax, TransUnion, and Experian. Thanks to the Fair and Accurate Credit Transactions (FACT) Act, you have the right to one free annual credit report from all three credit bureaus. You may also receive an additional free credit report if a creditor denies you within 60 days, you lose your job, you receive public assistance, or you are a victim of identity theft.
Many creditors do not report to all three credit bureaus, so each credit report will contain different information. In order to report financial information, financial institutions must pay. Many creditors choose to only report to one or two credit reporting agencies due to the cost.
A credit report contains a lot of information on your finances, such as:
- Payment History
- Account Balances
- Credit Inquiries
- Credit Limit
- Open and Closed Credit Accounts
- Debt Collections
How Does a Credit Report Affect My Credit Score?
Credit score fluctuations may worry you, but it’s entirely normal for credit scores to go up and down. If you see your credit score drop, it can be stressful when you don’t know why. The key to limiting credit score fluctuations is understanding how credit scores are calculated. A credit report provides essential information that directly affects your credit score.
Your credit history is split into five categories that directly affect your credit score. Each category on a credit report is worth a small percentage of your total credit score calculation.
The most critical financial category for credit scores is payment history. Your payment history accounts for 35% of your total credit score calculation. Ensuring that you make payments on time can help you maintain a good credit score. Missed payments can directly result in a credit score drop.
A simple way to avoid missed or late payments is to sign up for automatic payments with your credit card company. Many creditors offer this payment method. Money is automatically withdrawn from your bank account on your due date. You will need to provide your bank account information to sign up for automatic payments.
Credit Utilization Ratio
Your credit utilization ratio is the amount of debt you have compared to available credit. Credit utilization accounts for 30% of your total credit score. The more debt you have, the lower your credit score will be. To maintain a good credit score, keep your credit card balances low.
Using more than 30% of your total credit limit can negatively affect your credit history. Keeping credit card balances low can be difficult when your credit limit is low. If your credit utilization ratio is high, consider asking your creditor for a credit limit increase. A higher credit limit can make managing your credit utilization ratio easier if you have already used most of your available credit.
Length of Credit History
The age of your credit accounts makes up 15% of your credit score. The longer you maintain a credit account, the better your credit score will appear on a credit report. Suppose you successfully manage your revolving credit accounts. In that case, credit card companies may be more willing to qualify you for a new credit card account or higher credit limit. However, if you have missed payments on your credit report, the age of your credit card account may not be as significant.
Credit mix accounts for 10% of your credit score. Managing different types of financial accounts can be beneficial for credit scores. Borrowers should ideally have a mix of revolving credit and installment loans.
Revolving credit is any form of debt automatically renewed once the debt is paid off. An installment loan is a loan that gives borrowers a lump sum of money which is repaid through scheduled monthly payments. Managing a mortgage or auto loan in addition to credit cards could reflect positively on your credit report.
The number of credit inquiries you make directly affects 10% of your credit score calculation. If you have a bad credit score, you may have applied with many lenders in hopes of getting approval. But making more than six credit inquiries within one calendar year can result in a negative credit score change. If you say, “I need a payday loan immediately,” go ahead and apply for one! As long as you keep your number of inquiries low, opening new accounts may not severely damage your credit score.
Significant Credit Score Fluctuation May Be a Sign of Identity Theft
While you should expect credit score fluctuations, there may be cause for concern if your credit score changes dramatically. Identity theft has affected more than 60 million Americans and continues to be a common cyber threat.
Identity theft is when someone uses your personal or financial information fraudulently. Fraudsters use your information to open new credit or utility accounts, make payments, steal your tax refund, and more.
Warning Signs of Identity Theft
There are various warning signs of identity theft. If you detect any of the activities listed below, you can take steps to protect yourself.
Incorrect Billing Statement
You should be checking your billing statements periodically to ensure there is no fraudulent activity. If you notice suspicious withdrawals or charges on a bank statement, you may be a victim of identity theft. Contact your bank as soon as possible and inform them of the fraudulent transactions on your financial account.
Incorrect Credit Report
An incorrect credit report can be a sign of identity theft. Credit reports could have outdated information which needs to be corrected. But you should immediately contact one of the three credit bureaus if you notice new accounts you did not open. The credit reporting bureau will inform the other reporting agencies of the fraudulent activity.
Missing or Unfamiliar Bills
If you usually receive paper bills, but then those bills go missing, you may be a victim of identity theft. Fraudsters will attempt to steal mail to obtain personal information that will allow them to open financial accounts in your name. If you start receiving bills for unknown accounts, that may also be a sign of identity theft. Contact the creditor right away and report the activity to the Federal Trade Commission.
Calls from Debt Collectors
Suppose you receive calls from debt collectors about unfamiliar bills and credit card debt. In that case, a fraudster may have stolen your identity. Review your credit reports and contact the credit reporting agencies as soon as possible. You will need to dispute the fraudulent activity, so ensure you have the necessary information readily available.
Credit scores drop for a variety of reasons. Understanding how credit scores are calculated can help you prevent a significant credit score drop. For example, avoiding late or missed payments can help you maintain a stable credit score that doesn’t go up and down. Reviewing your credit reports can help you prevent identity theft and better understand your credit position.