Reasons Why Your Credit Score May Drop
Whether you need money to boost your business or meet your daily personal expenses, access to finance will play an important role in helping you get ahead. However, before you apply for financial assistance, you will need to establish whether you are eligible and if you qualify for the financing you need.
Today, a good number of lenders will look at your credit rating before they can approve your loan application. This is one reason why it’s so important to have a good or great credit rating. The first step to doing this would be to identify the various reasons why your credit rating may drop and find out effective ways of addressing them.
If you’ve been monitoring your credit score closely and noticed that it suddenly took a drop, it could be a number of different factors. We all know that missing even one payment can make your credit score go down, but what about the other “not so obvious” reasons for a drop?
It happens every day: someone runs a credit report and realizes that their score has dropped. Why? Did they do something wrong? Not necessarily. A lot of factors go into the complex calculation of credit scores. Some of those factors are tied to personal financial choices, and others are out of the consumer’s control entirely and must be adjusted to or waited out.
Here are 15 reasons for a sudden drop in a credit score:
- Total number of accounts –
The number and mix of different types of credit is a small but present factor in determining a credit score. A few lines of credit that lack diversity act as a warning flag to some lenders, hinting that this customer is inexperienced in balancing multiple debts and paying them off responsibly.
- Total credit card utilization –
This figure is determined by the total debt on all of the cards divided by total available credit limits. If a large percentage of that total credit is in use on a month by month basis, it sends the signal to lenders that this customer relies on credit to pay their bills. There are two reasons why this figure may suddenly change:
- Large Purchases
The total credit card utilization number may experience instability if someone occasionally makes large credit card purchases. If it takes the customer more than a month to pay off the expensive item, or if the balance is reported before a payment is received, then the total credit card utilization will rise.
- A Credit Limit was Lowered
This has a similar impact to buying an expensive item; it changes the total credit card utilization number in a less-than-favorable way as the total balance on cards becomes a greater percentage of total credit available.
- Average age of open lines of credit –
The longer a person maintains a credit account, the more reliable they appear to credit agencies. Scoring models factor the age of open credit lines into the calculation. If a credit card is closed by the customer or canceled by the lender that shortens the apparent active history and credit scores suffer. Opening a new account may not help as that can also lower the average age of the customer’s accounts.
- Changes in the credit score formula –
Determining credit is a complex business, and agencies continually try to refine their formulas to make them a better indicator of a person’s credit risk. Older and newer versions may be in use at any time by different agencies, and when a new, slightly changed formula is applied, it can impact a person’s credit score without them doing anything to trigger that drop. Here’s an article about credit score systems: https://www.advantageccs.org/articles/about-credit-score-systems
- Missed or late payments –
This is one of the most obvious reasons why a credit score may decline. Lenders look at a report to determine how likely the person is to pay off debts. Missing just one payment has a negative effect on the credit score. This effect is, unfortunately, magnified if the customer has an otherwise excellent record with no prior missed payments. One of the factors that will determine your credit score is your payment history and financial behavior over a period of time. This is why making late payments or missing out on making any payments on your loans will have a significant impact on your credit score. When you do not fulfill your financial obligations in good time, lenders will be wary of you. In the end, there is a chance that your credit score will drop.
- Derogatory marks on the credit report –
This is the other obvious reason for credit score decline. Derogatory marks include tax liens, accounts that are sent to collection agencies, and filing various kinds of bankruptcy. They tend to hit in clusters, with one financial issue spiraling into a more serious one. This often happens in the case of business failure or catastrophic medical bills. While all the information contained in your credit report could be accurate, negative items will affect your credit rating. Some of the events that would make for negative items include foreclosure and bankruptcy. Since such items are likely to remain onyour credit file for a considerable number of years, they would cause your credit rating to diminish. There is no telling the exact time you would need financing to meet your expenditures, an issue that makes it advisable to avoid events that could result in negative items in your report.
- Derogatory marks dropped off –
How can the removal of derogatory marks harm a credit score? The answer lies in scorecards. FICO compares people within credit categories, known as scorecards. People can be moved between scorecards due to derogatory marks such as collections and bankruptcy. The customer may have an excellent credit when compared to others who have recently filed for bankruptcy, but that can change years down the line. Those marks eventually drop off the credit report, the person will suddenly be compared to peers who have never filed bankruptcy, and their credit score may suffer. Keep a healthy credit and pay debts off promptly and the score should recover over time.
- Settling on a past due account –
Lenders may “settle” and accept less than the full amount they are owed. This is good news for people struggling with debts beyond what they can pay, but bad news for the credit score. The unpaid amount is reported to credit bureaus as a “deficiency balance” and often has the same negative effect on your score to extremely late payments.
- Shopping around for credit –
Lending agencies look with suspicion on any evidence that a customer is shopping for numerous kinds of credit. This paints the picture, perhaps unfairly, of a person who is desperate for credit, living beyond their practical means, and not in a good position to pay the loan back. There are two common signals that someone is shopping for credit:
- Hard Credit Inquiries
Customers’ credit reports receive hard credit inquiries when applying for new credit or for major financial commitments such as car loans or mortgages. A single inquiry has little effect, but some models penalize the score when multiple inquiries come in at once.
- New Applications for Credit
New credit report inquiries make up 10% of the credit score. A customer’s score is in jeopardy every time they apply. Fortunately, these inquiries only apply for the first 12 months. If there are no further credit applications, the credit score should rebound in a year or two.
- Inaccurate information on your report –
Your credit report will also play a crucial role when it comes to your score. The information contained in the report will have a direct impact on whether your loans will be approved or not. This is why financial experts recommend that you check the report on a regular basis. In the event of inaccurate or outdated information in your report, there is a real chance that your score will take a dip. If you notice that there is missing or inaccurate information, you should consider registering your dispute with the relevant authorities.
- You closed a credit card –
In case your credit card has a balance and you choose to close it, you can be sure that your credit rating will drop. The fact that the card was closed gives lenders the impression that you are a high-risk borrower. In essence, you may come across as a borrower who does not exhibit responsible use of credit. What this means is that your credit rating will diminish and you will have a more difficult time accessing credit.
- Opening too many new accounts at once –
While in principle opening numerous new accounts will not be a bad thing, the period over which you open the accounts will affect your credit ratings. A good number of credit reporting agencies will be worried when your average account age reduces significantly within a short period of time. Since the account age helps in demonstrating your financial behavior and discipline, a lower average account age will lead to a drop in your credit ratings.
- You charged too much on your credit card –
The amount of available credit that you use will affect your credit ratings, effectively making you either more or less attractive to lenders. In simple terms, your debt-to-credit ratio will affect your eligibility for credit as well as determine how much you qualify for when it comes to financing. If you use so much of the credit available, the ratio will be higher. This means that your credit ratings will dip, making it harder for you to get financial assistance.
- A canceled card –
One of the factors that determine your credit rating is the length of your credit history. In the event that you cancel one of your credit cards, information about your past financial behavior and discipline will be lost. At the same time, canceling a credit card will raise your debt to credit ratio, a factor that will lower your credit ratings. This is why it is always advisable to have and maintain your accounts for a long period of time.
- One of your credit limits was lowered –
If your lender lowers the credit limit on one of your credit cards, your credit rating will be adversely affected. Credit reporting agencies will notice a rise in credit utilization, effectively leading to a drop in your ratings.
The credit reporting system and credit scoring system are hard to understand. It doesn’t help that these reporting agencies don’t release all their information and keep some things a secret. So trying to figure out exactly why your credit score dropped can be a difficult task.
Once you understand the specific reason why your credit rating drops, you will have to make sure that you improve your financial behavior. In addition, maintaining your credit rating at a certain level will go a long way in helping you access the financing you need to move you closer to financial freedom.
If you follow the tips and advice from above you can more than likely work everything out, and then you can set about fixing the problem. It will take some time to increase your score no matter what. It won’t increase overnight, no matter how much we wish it would. Be patient and just do the right things to bring your score up! Good luck and if you have any questions about your credit score, credit score, or how to get out of debt, give us a call toll-free at 1-866-699-2227 or visit us at www.advantageccs.org.