As someone who gets credit report notifications, you should be familiar with changes in your credit score. Well, credit score plays an important role as it determines your ability to repay the loan. A good credit score allows you to achieve lower interest rates and help you buy a house at ease. It is quite common for your credit score to fluctuate with minor increments.
If you ever rejoice when your credit score increases, you are likely also familiar with the dread when it drops. If you notice a big drop of 15 points or more, it might be a cause for concern. It can be baffling and frustrating, especially when you cannot pinpoint what caused it.
Certain factors majorly determine your credit score. You may notice that your score differs slightly from the three credit bureaus. This difference is because of various credit scoring models used to collate your score. As the information on your credit report changes, your score also changes. So, it may help to trace the drop in your score to recent information on your report.
Sometimes, there’s no one cause for a drop in your credit score. However, it is crucial to investigate the possible cause for the drop. In the FICO score models, payment history, credit card balance, and length of credit history are the greatest factors affecting credit score. Finding the source helps you know if your action, inaction, an error, or even identity theft was the cause.
Missing Or Late Payments
As mentioned earlier, payment history is the most important factor that affects your credit score. In the FICO score models, payment history accounts for 35% of your overall credit score. This means that a sole late or missed payment will have a significant negative effect on your score. So, always make your payments on time. You can also consider setting up automatic payments to avoid delayed payments.
Your credit card issuer typically reports past due bills (over 30 days) to a credit bureau. If your bill is over 60 – 90 days, the negative effect on your credit score will be greater.
How much your credit score drops depends on other information on your credit report. Typically, the drop will determine how good or bad your credit score is. Thus, the better your credit score, the steeper the drop for a late or missed payment. Also, the drop will be greater if you have no previous late payments.
Late or missed payment will result in credit card issuers reporting you, the interest rate shot up, and a late fee inclusion. In addition, the late payment entry added to your credit report can stay there for up to seven years. Ultimately, you may lose your credit card rewards and get a charge-off.
Contact your credit card issuer if you cannot meet up with a payment. This is important because your payment behavior after you miss a payment affects how quickly you can recover your score. Your issuer might draw up a repayment plan for you, and you can stop them from reporting you to the credit bureaus. To help with on-time payments, you could keep track of due payments with a spreadsheet. Additionally, you could also sign-up with an automatic bill payment platform.
To avoid late payments, ensure to make all your payments on time. Positive payment history can stay on your credit record indefinitely and strengthen your credit score.
Increased Credit Utilization Rate
Credit utilization is the second major factor that affects credit scores. Also called the debt-to-credit ratio, it accounts for about 30% of your FICO score. Your credit utilization ratio calculates your outstanding credit balance against your overall revolving credit limit. Credit utilization does not factor in installment loans such as mortgage loans or student loans. It only takes into account revolving debts and credit cards.
To explain, if your credit limits across your cards are $20,000 and your total balance is $2,000, your credit utilization ratio will be 10%. You must keep this ratio below 30%, as 30% and below is considered “good credit score utilization.” The closer to 0% you are, the better. A low ratio not only helps to improve your score, but it can also build it.
Your ratio increases when you make a large purchase or max out your cards. Even if you pay your balance in full, your credit score could still drop. Your credit issuer is unlikely to send credit reports when your credit utilization rate is 0%. On the last day of the billing cycle, your credit issuer reports your balance; this could cause a dip. A high ratio may show potential lenders that you are financially overstretched.
You could request a higher credit limit to lower your credit utilization ratio. This is useful if you pay your bills in full but still get close to the 30% mark. Sometimes, it might also help to pay your bill twice a month if you plan on making an expensive purchase. You could also set up an automatic credit balance alert that can notify you when you are close to 29%. This way, you can avoid making big purchases on one card and crossing the 30% threshold.
Paid Off Loan
Even though paying off a loan is a win, it can, unfortunately, result in a lower credit score. You must understand this process as it will help you bounce back. Credit score calculation is quite complex and is hinged on various factors. This is why loan paying may not have a positive impact as you would expect. If the paid-off loan changes your credit utilization, credit mix, or average account age, it may lower your credit score.
Generally, having a mix of revolving debts and installment loans helps your score. It shows the credit issuers that you can manage different debts. Thus, if paying off one of them reduces the diversity of the mix, your score could drop. For example, if paying off a mortgage leaves you with fewer credit cards, your score decreases. Similarly, your score could also dip if you pay off a credit card in full and close the credit card account. This is because you have one less credit account, thus inadvertently decreasing the amount of credit you have. This move increases your utilization ratio. Finally, having an aged account is good for your score even though it is not in use. If you close that account, it may dramatically reduce the average age of your credit accounts, thus dropping your score.
In this case, some may consider taking another loan to increase their credit scores. However, it does not always work, especially if the paid-off loan was an old account. If the paid-off loan decreases the diversity of your credit mix, taking a new type of loan may help your credit score. However, if you cannot make payments on time, do not take out a new loan, no matter how much it may help your score.
The diversity of your credit mix does not mean you should avoid paying off a loan. There are other ways of building your scores without the need for debt diversity.
Application for Multiple Lines of Credit
Applying for new lines of credit over a short period could cause a drop in your credit score. It makes lenders see you as a risk, as it seems like your finances are in bad shape. This may reduce your chances of getting approved for new credit.
Moreover, if you apply for credit, your lender performs a hard inquiry on any of your credit reports. A hard inquiry is when a card issuer or a lender looks through your credit report to decide your approval. It typically takes off about five points from your credit score. This number largely depends on your previous credit history and activity. However, if you apply for multiple credits over a short period, the lenders make more hard inquiries. As a result, the points compound and cause a significant dip in your score.
It is important to note that monitoring your credit with certain platforms constitutes a soft inquiry. Soft inquiries include periodic checks from your lender, promotional credit offers, and rate-shopping mortgage loans or auto loans. However, if you are rate-shopping, FICO suggests doing it over 30 days. This way, they can be grouped as one inquiry. But your score will still drop even if you apply for multiple credit lines in a short period. Typically, soft inquiries do not make any impact on credit scores. This is because the credit bureaus do not include the score when collating credit scores.
Record of hard inquiries can stay on credit reports for up to two years. However, the effects of an inquiry fade quickly. There will either be a new account representing the risk or none after a billing cycle. After twelve months, FICO will ignore the inquiry.
Closing a Credit Card
Closing a credit card you no longer use seems like a no-brainer, but think twice because it could lower your credit score. A closed credit card affects credit scores by reducing available credit and the average credit history length.
The length of your credit history accounts for 15% of your FICO score. When you close an old credit card, you make the account younger. Having older credit accounts on your record makes for a more positive score. However, if your current card attracts a high annual fee or causes you to spend more, you may need to close it. There are benefits of having an old account that can help improve your credit score. It is vital to weigh the pros and cons in this case.
Before you close an account, calculate your credit utilization ratio. If closing the account increases your ratio to almost 30%, you could reconsider. Alternatively, you could decide to pay up all your credit card balances.
If you must, request a higher overall credit limit on your account. The disadvantage of this request is that it could present as an inquiry on your record. An inquiry can cause a drop in your score, especially when you plan on taking a big loan soon.
The higher the age of your accounts, the better your credit score. Closing an account, you have had for a long time may cause your score to drop. However, accounts closed in good standing typically remain on your credit report for up to ten years. When they fall off your report, it causes a dip in your score.
If you close your card, you can ask your issuer to switch it for another with no annual fee. Alternatively, you can keep it away and avoid using it, although that could also cause your score to drop after a while.
Derogatory Marks on Your Credit Report
Derogatory marks are negative information on your credit report. Negative information includes charge-offs, tax liens, judgments, lawsuits, bankruptcy, and even late payments. This negative information can stay on your record for seven to ten years. As credit reports depend on the information they get, this negative information can lower your credit score. A chapter 13 bankruptcy can remain on your account for seven years, while chapter 7 can stay for ten years.
On some scoring models, old derogatory marks count more than more recent ones. Charge-offs can remain on your account for up to seven years. Once an account goes to the collection and extends past six months, a charge-off will show on your record. Even when a debt is charged-off, you are still liable to pay it off.
Derogatory marks typically have a lessened effect over time. If you notice marks on your report that you think are wrong, you have a right to dispute. It is important to verify the derogatory mark first, then take up the dispute with the major credit bureaus. Next, follow their dispute process, which usually involves filling out a form online or writing to them.
Make all bill payments on time to prevent negative information from showing up. Make sure to spend within your credit limit and monitor your report for changes.
Bankruptcy or Foreclosure
Filing for bankruptcy or foreclosure undoubtedly causes the most damage to credit scores. Often, a series of missed and late payments lead up to these events. While these late payments damage your credit score, the events of a foreclosure or bankruptcy do even greater damage.
Your credit score can drop sharply when you file for bankruptcy. The negative entry can remain in your credit report for many years. The severity of the drop depends on several factors, including your credit score before you filed and the type of bankruptcy you filed.
Borrowers with piling debts might initiate the legal process of filing for bankruptcy to relieve themselves from paying debts. This singular act causes the greatest damage to a person’s credit.
Foreclosure happens when a mortgage bank or mortgage lender legally takes ownership of your house due to consecutive missed mortgage payments. In terms of credit damage, foreclosure comes a close second to bankruptcy.
Besides the damage to your credit score, these events also lead to long-term disadvantages. For example, you may not qualify for certain kinds of loans if such events are in your credit history. If by chance, you qualify for some borrowing, your history might make your lenders charge higher interest rates.
Also, with a foreclosure event in your credit history, you may be unable to convince a mortgage lender to take you on in the future.
A bankruptcy report might stay on your credit report for up to ten years, depending on the kind of bankruptcy you filed.
A Chapter 7 bankruptcy clears away most of your debts and essentially resets your finances. Also called liquidation bankruptcy, this event could result in foreclosure of your home, eviction, and repossession of your property. This kind of bankruptcy damages your credit score and stays on your credit report for 10 years.
A Chapter 13 bankruptcy, on the other hand, structures a repayment plan for borrowers. The plan usually lasts for three to five years, after which some of your debts might be “discharged .” This kind of bankruptcy stays on your report for 7 years.
Cosigning a Loan
By cosigning a loan, you state that you – and the original borrower – are equally responsible for paying it off. If the borrower cannot pay the loan, you will be responsible for paying up. When you cosign a loan, the payment history can show up on both your and the borrower’s report. If the borrower defaults, misses a payment, or makes a late payment, it will show up on both credit reports. Any negative information incurred will tank your score even when you are not the primary borrower.
Before cosigning a loan, ensure that your credit is good enough to handle both accounts. It could also help to have a budget for monthly payments should the original borrower default in payment. Before cosigning, set expectations with the original borrower and ensure they can pay their loan. If you are not convinced, then desist from cosigning altogether.
Cosigning might affect your future borrowing abilities, as lenders may assume that your loan repayment capacity is reduced due to the loans under your name. Also, a hard inquiry into your account might occur when you cosign a loan, and this can further cause your credit score to reduce.
Cosigned loans will fall under the Amounts Owed category in your FICO credit score, and this category makes up 30% of your score. Therefore, cosigning a loan can cause your score to tank in the event of missed or late payments.
A cosign can also increase your debt-to-income ratio, thus making it difficult to secure a loan of your own. Also, cosigning an account in a relationship that ends in divorce does not exclude you from paying it off. Check your credit reports thoroughly to determine if you are financially ready to cosign a loan.
Adding an Authorized User to Your Credit Card
As a cardholder, you can decide to add someone as an authorized user to your credit account. This individual would receive a duplicate card that charges
your account when they use it. Including one or more authorized users in your credit card account might affect your credit score.
An authorized user can access your account but is not responsible for making payments. This responsibility remains with the account holder. The authorized user’s use of your card increases your credit utilization rate. This might cause your credit score to decrease significantly.
Being an authorized user of another account holder can also affect your credit score. Thus, it’s essential to know in what ways this setup can affect your credit score.
To ensure you do not incur unnecessary debts and high repayments on your account, it’s best to set necessary spending limits on the authorized user’s card. Alternatively, you could speak to the user about responsible spending habits and card usage.
Medical Bills Sent to Collections
Unpaid medical bills can greatly affect your credit score. If bills remain unpaid for a while, they are forwarded to debt collectors, and the negative mark could remain in your credit history for a long time.
These bills are more likely to affect credit scores when they go unpaid for many months and get forwarded to collections. Formerly, medical bills would remain on your credit report even after being paid.
However, as of July 2022, paid medical bills would no longer appear on your credit report. Also, as of July 2022, it would take one year before your medical debts reflect on your credit report. So, at this time, medical bills may take a while before showing up on credit reports. And since credit reports influence credit scores, unpaid bills may cause a person’s credit score to drop.
The occurrences of identity fraud are rising daily as fraudsters are constantly on the prowl. Still, it’s hard for anyone to believe that they’ll ever be a victim of it. When you fall victim to identity fraud, it could cause discrepancies in your credit information.
This can cause your score to drop significantly. When a fraudster gets a hold of your credit details, they might open new lines of credit, max out the multiple credit cards, and default on their payment. If they manage to get hold of your Social Security Number as well, they could open a new credit account. These missed payments would certainly cause your score to dip.
There are several activities that an identity thief can carry out on your account that can cause a dip in your score. Identity theft could result in you losing up to 100 points in your credit score. Thus, it’s best to stay one step ahead to ensure you don’t fall victim to identity fraud.
For example, it would be helpful to set up SMS or email alerts with your credit card companies. With these alerts, you’ll always be abreast of whatever transactions happen with your credit cards. Additionally, you could practice strict credit monitoring. If you can monitor your credit regularly, you may notice unauthorized accounts opened in your name quicker. You can then proceed to report to any of the credit bureaus.
If you have fallen victim to identity theft, you must make a recovery plan, like placing a fraud alert on your profile. Additionally, you ought to fill out a form with the FTC to kick off the disputing process. You could also perform a credit freeze that restricts access to your credit file, thus making it more difficult for fraudsters to hack.
Conclusion: Is It Common For Credit Score To Fluctuate?
A credit score drop can seem like a blow that leaves you wondering what you did wrong. However, a credit score drop is not a death sentence. Building a good credit score is still possible after a dip, and there are actionable steps to take to rebuild one’s score. Credit scores drop and peak, and it is vital to know how each factor affects the score. Knowing these factors can help you bounce back when your score takes a plunge.
Your payment history is unarguably the most impactful factor on your credit score. Your credit utilization ratio, credit mix, and credit history length also play major roles. If you can single out the cause of the drop in credit score, you can know how to tackle the rebuild. Sometimes, a drop can be caused by misinformation on your credit report or negative information that doesn’t belong to you.
Applying for new credit accounts can also affect your credit score. Additionally, a credit score drop can show that you are a victim of identity theft, however unlikely it may seem.
As shown, there are a few reasons your credit score drops, each as important as the next. Use your credit responsibly, make early bill payments, avoid new debts, and monitor your credit regularly to rebuild your score.