Why Your Credit Score Drops: 4 Common Causes Explained
If you don’t have much — or any — experience with credit at this stage of your life, you may wonder why people worry if their credit score goes down. Put simply, without a good credit score, your ability to get credit at an affordable rate will likely be severely limited.
“Creditors want to lend money to people who they believe are likely to repay their loans so that they can keep on making money — not losing theirs,” said Matthew Jimenez, CEO of My Credit Repair Clinic. “Lenders use your credit score as a reference when deciding whether someone can get a loan, and what interest rate should be charged on that loan.”
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Your credit score is made up of a variety of factors that are weighted according to the credit scoring model being used. The most common credit-scoring model to date is FICO, created by the Fair Isaac Corporation, which is used by over 90% of top lenders.
While most people know that irresponsible use of credit can cause your credit score to dip or even plummet, bad credit behavior isn’t the only reason your score might go south.
“FICO scores can drop for a number of reasons — even when you’re in great financial health and do a good job of managing your cash flow well,” said Eric Roberge, CFP and founder of Beyond Your Hammock. “This surprises a lot of our financial planning clients who make above-average incomes and may not even have any consumer debt to their names.”
Here are four reasons your credit score could go down — some through no fault of your own.
1. Poor Payment History
“One of the main things that can have a severe impact is your payment history,” said Stephen Weyman, co-founder of creditcardGenius. “Lenders typically provide ratings for borrowers to the credit bureaus depending on whether their payments are made on time. Making late payments to your credit card or missing out on them completely will also be reported to the credit bureaus. These records often remain in your credit file for seven years and can negatively impact your score, which, in turn, can prevent you from qualifying for loans or low-interest rates as you’re seen more as a risk to the lender.”
2. Credit Utilization
“One of the biggest reasons for a credit score drop is credit utilization,” said Roberge. “If you use more than 30% of your available credit all at once, this can cause your score to drop (sometimes significantly). For example, say you have a $10,000 credit limit. If you make a $7,500 purchase, that takes up 75% of your available credit, and you may see your score drop after that purchase posts. It doesn’t matter if you have the cash available to pay for your purchase or pay off the card on time and in full and therefore don’t actually incur any debt or owe interest. It can still negatively impact your score simply because you used up a large amount of your available credit.”
But Roberge said the damage is not permanent.
“The good news is that your credit score should eventually recover, but for the most part, you want to monitor how much of your available credit you use at any one time and keep that usage to 30% or less of your total credit limit,” he said. However, lower is better, and many experts even suggest keeping ideally under 10%” for top-tier scores.
3. Hard Credit Inquiries
“When people are looking to secure a loan, open a credit card, consolidate debt or get financing on a car or other major purchase, this will almost always require a hard credit inquiry, which can cause your credit score to go down,” said Carter Seuthe, CEO, Credit Summit. “People often don’t realize the difference between a hard and a soft credit inquiry, and less-scrupulous companies will hide this information in fine print.”
According to Experian, hard inquiries can cause a small, temporary dip — typically a few points. The better your credit is, the less impact this type of inquiry will have. And your score should rebound within a few months. However, if you apply for several different loans or credit cards within a short period of time, your score could drop 15 points or more.
4. Errors on Your Credit Report
“Errors on your credit report can be another quick way to drop your score,” said Tony Wahl, director of operations at Credit Sesame. “If you see any incorrect marks on your report, be sure to dispute them with the credit bureaus as quickly as possible. When you take the time to understand what affects your credit score, you’re taking the first steps toward having better control over your finances.”
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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