If you’ve got some financial know-how (and we’re betting you do, given you’re here on our site), chances are you’re already in the habit of regularly checking your credit score. If not, now’s a good time to start. You can easily access your credit score for free through platforms like Credit Karma or the big three reporting agencies — Experian, TransUnion, and Equifax. Whether you’re cruising with an impressive credit score or diligently building it up, it can be quite disheartening to witness a sudden drop. “What caused that?” you might ponder.
The reality is, your credit score is composed of various components. A minor dip in your score is often nothing to lose sleep over, especially if you typically manage your finances prudently. However, if the decline is substantial or seems inexplicable, it might warrant a closer look. Here are some common culprits behind a drop in your credit score.
Hard Credit Inquiry
If you’ve recently sought new credit, chances are it entailed a hard credit inquiry. Whether it’s for another credit card, an auto loan, or any other form of credit, such applications typically cause a temporary dip in your credit score. If you apply for several lines of credit within a short timeframe, the impact on your score can be even more pronounced.
The silver lining is that hard inquiries aren’t permanent fixtures. They remain on your credit report for a duration of two years. Furthermore, they only affect your score if they occurred within the last 12 months. Additionally, they contribute to only about ten percent of your credit score, meaning that applying for a new credit card or loan should not significantly tank your score.
Major Purchase
One of the key factors in calculating your credit score is “credit utilization.” If you’re unsure about this term, it’s quite straightforward. Essentially, the more credit you have available but aren’t actively using, the better your credit utilization ratio. For instance, having a credit card with a $15,000 limit and maintaining a zero balance is excellent for your utilization. Conversely, if the same card consistently carries an average monthly balance of $12,000, it significantly impacts your utilization ratio.
If you recently made a hefty purchase—like a new TV, a down payment on a car, or a vacation—using credit, your credit score might take a hit. Credit bureaus observe an increase in your utilization, which prompts an adjustment in your score. The upside is that this could be a temporary setback. Perhaps you opted to use your credit card to capitalize on rewards points. If you promptly pay off the balance, your utilization returns to a healthier level. However, if you’re relying on borrowed funds to indulge in expensive items, your score could remain lower for a while. Additionally, such actions are generally viewed as imprudent financial behavior.
Something Was Sent To Collections
If one of your debts has been handed over to a collection agency, expect your credit score to take a hit. And it’s not just limited to traditional credit products like credit cards, lines of credit, or auto loans. Unpaid utility bills (such as for heat, gas, or electricity) or telecom bills (for internet, TV, or cell phone services) that linger unpaid for too long can also end up in collections, tarnishing your credit report.
It’s crucial to recognize that collection entries on your credit report don’t vanish on their own. Even if you believe there’s been a mistake, it’s your responsibility to rectify the situation. Perhaps you simply forgot about an outstanding bill, but that oversight reflects poorly on your financial history. Reach out to the company that owns the debt—though be aware it might have been sold to a third party if it’s already in collections. Work out a repayment plan and commit to fulfilling those terms. Once the debt is settled, the collections notice will eventually be removed from your credit report, thereby boosting your score.
Your Limits Were Lowered
Let’s revisit the concept of credit utilization, but from a different angle this time. Instead of the issue stemming from a large purchase that eats into a significant portion of your available credit, your credit score can also suffer if you suddenly find yourself with less available credit— even if you haven’t utilized it.
There are various reasons why your credit limits might be reduced. Perhaps you voluntarily requested a lower limit to curb overspending temptations. Or maybe you opted for a lower limit to enhance the appeal of a mortgage application. Alternatively, your bank might have imposed a lower limit on you. While it’s uncommon for banks to take this step, it does happen in situations where you’re perceived as a high-risk borrower.
The consequence of reduced credit limits is a decrease in credit utilization, consequently leading to a lower credit score. So, if you’ve been diligently chipping away at a credit card balance and have made substantial progress, think twice before requesting a lower limit. While you might believe you’re safeguarding yourself from potential overspending, you could inadvertently harm your credit score in the process.
You Missed a Payment
As you might expect, timely payments play a significant role in determining your credit score. Missing the due date for your cell phone bill by a day probably won’t cause much concern. However, any payment delayed by more than 30 days will be reported to the credit bureaus. This applies not only to utility bills but also to obligations like car loans, mortgage payments, and minimum credit card payments.
Even a single instance of late payment can lead to a drop in your credit score. Consistently missing payments will have an even more pronounced negative impact. Unfortunately, rectifying this kind of decline isn’t a quick fix. Payment history remains on your credit report for an extended period, meaning that only several months of punctual payments will help restore your score. If you believe a missed payment on your credit report is erroneous, it’s crucial to take immediate action to address it.
You Closed a Credit Card
Closing a credit card can have a couple of adverse effects on your credit score. Firstly, it reduces your available credit, impacting your credit utilization ratio—something we’ve discussed the significance of previously. Secondly, it may shorten your credit history, particularly if you’re closing one of your oldest credit accounts. Generally, the longer your credit history, the more favorable it is for your credit score.
Now, suppose you’re contemplating getting rid of that entry-level credit card you’ve held onto since you turned 18, in favor of one offering better rewards and a lower interest rate. The optimal solution, surprisingly, is to retain the old card—especially if it doesn’t come with an annual fee. Tuck it away in a drawer and forget about it. It serves as a safety net for emergencies, and its presence helps maintain your credit score.
The same principle applies if you’re considering a balance transfer from one card to another to save on interest. Resist the urge to immediately close the now zeroed-out card. Instead, simply cease using it while keeping it open.
Did Someone Else Miss a Payment?
It’s crucial to keep in mind if you’ve ever co-signed on a financial product. Perhaps a friend or relative didn’t quite meet the requirements for a credit card or car loan on their own. Wanting to lend a helping hand, you agreed to co-sign with them. While you may have made an informal agreement that you wouldn’t be responsible for any payments, unfortunately, banks and credit bureaus don’t recognize pinky swear promises from family members.
If a debt you co-signed on starts missing payments (or worse, gets sent to collections), there’s unfortunate news—you’re on the hook for it too. It might seem unfair, especially since you weren’t the one who acted irresponsibly. However, that’s the risk of co-signing any loan or credit application for someone else. It’s also why financial experts typically advise against it unless absolutely necessary.
If a co-signer is struggling to meet their financial obligations, your credit score will suffer as well. The only viable course of action is to communicate with the co-signer and collaborate on a plan to get back on track. If you’re concerned about your credit score, you might consider offering them an interest-free loan to help catch up on payments. However, there’s the dilemma that they’ve already demonstrated a history of not repaying debts, presenting a challenging situation with no straightforward solutions.
Did an Authorized User Do Something Fishy?
Even if you haven’t co-signed for anyone, there are still avenues through which someone else could negatively impact your credit score. It’s quite common for parents to add their children as authorized users on their credit cards around the age of 16. This often aligns with their children getting their driver’s license, as parents want them to have the means to handle emergencies if they’re ever stranded. However, authorized users aren’t limited to children; some individuals extend this privilege to their spouses or friends who are working on improving their credit.
If your authorized user behaves in an unexpected manner—whether by making significant purchases, attempting to alter your credit limit, or failing to contribute their agreed share of expenses—your credit score may suffer. While you have the option to remove an authorized user at any time, doing so won’t erase any damage they’ve already caused. Therefore, it’s essential to only grant authorized user status to individuals you wholeheartedly trust. Otherwise, be prepared to bear the consequences of their actions.
There’s a Legitimate Mistake
Mistakes are an unfortunate reality. Not the result of your own financial missteps, but legitimate errors originating from banks or credit bureaus. Regrettably, such occurrences are all too common. Perhaps you have a common name, leading to your credit information being entangled with someone else’s. Or maybe a simple typo led to a payment you definitely made not being credited to your account. It’s understandably frustrating and stressful to witness your credit score plummet despite knowing it shouldn’t.
However, there’s no need to panic. These errors can be rectified. Firstly, gather as much verifiable evidence as possible to substantiate the mistake’s existence. This might include bank statements, receipts, tax documents, collections notices, or any other evidence proving the inaccuracy of the credit report. Then, contact the credit bureaus and formally dispute the error. If you’re telling the truth, there’s likely a legitimate avenue to correct the mistake. Remain patient throughout the process.
Identity Theft
In more severe instances, you might find yourself a victim of identity fraud. This goes beyond a single missed bill payment; instead, you could discover multiple new credit applications opened in your name within a short timeframe. It can be a terrifying experience, but there are steps you can take to resolve it. Firstly, report the theft of your identity to the government and the three major credit bureaus. You may need to file formal disputes for each unauthorized attempt to open credit under your name. Additionally, contact your bank and request a freeze on your credit.
Resolving identity theft is not a swift process. It may take months, or even years, to completely clear your name. However, maintaining persistence is crucial, and eventually, your credit score will bounce back. One of the most effective measures you can take to prevent extensive identity theft is to regularly monitor your credit report. This entails more than just glancing at the overall numerical score; take the time to thoroughly review the entire report. If you spot anything suspicious or unexplained, don’t hesitate to address it promptly.
Your Old Bankruptcy Expired
Hopefully, you’ll never find yourself in a situation where bankruptcy becomes your only recourse. Nevertheless, for many Americans each year, declaring bankruptcy becomes an unfortunate necessity. While it undeniably inflicts severe damage on your credit score, when you’re entrenched in such dire financial straits, viable options are often scarce.
If you have a bankruptcy in your financial history, you might observe a decline in your credit score when it reaches the seven-year mark—or ten years for a Chapter 7 bankruptcy. Initially, this may seem counterintuitive. After all, shouldn’t your credit improve as time elapses since the bankruptcy?
When a bankruptcy is removed from your credit report, you may transition to a different credit “scoring system.” Consequently, you are now assessed against individuals who also lack a bankruptcy record, as opposed to those who have filed for bankruptcy. This transition can lead to a drop in your credit score. However, try not to become overly distressed by this occurrence. In the long run, having the bankruptcy behind you (and removed from your credit report) significantly benefits your credit score. While witnessing a temporary dip in your score may be disheartening, ultimately, it’s advantageous to be part of a new scoring system alongside other financially responsible individuals.
In Conclusion
Credit scores may appear complex at first glance. However, with a bit of research and education, they become more manageable to comprehend. The key factors to remember are to consistently pay your bills on time, avoid maxing out your credit utilization, and refrain from overextending yourself financially. Additionally, exercise caution when allowing others to use your credit, whether through co-signing agreements or authorized user privileges.
If you notice a sudden decline in your credit score, resist the urge to panic. It’s likely attributable to something identifiable and explainable. Moreover, your score is likely to recover if you take the appropriate measures. However, don’t expect instant results. Credit scores typically evolve slowly, considering multiple years of financial history. Therefore, one month of responsible financial behavior isn’t sufficient to magically repair a low score. Remain patient and prudent, and your score will gradually improve over time.