Credit scores are undeniably important. But they’re also easily misunderstood. It’s easy to assume that scores have changed for no reason. And it’s natural to feel a little panicked when it looks like your credit score is dropping without any discernible cause. But you’ll soon see that there are a number of logical reasons why people see their credit score drop. And, likewise, you discover solid solutions to fix those problems.
What Is a Credit Score and Why Does It Change?
People often think of a credit score as a fixed value that perfectly and objectively measures their financial stability. This can cause a lot of unnecessary concern. For example, you might look into your credit score before working with a pool loan calculator and become concerned if your score is lower than you’d assumed. But it’s important to remember that any inquiry is only one single data point.
You don’t really have a single, unique, credit score that’s universally shared. A credit score is simply a value arrived at by a specific financial entity using its own specific methods. As such, you shouldn’t panic if your credit score seems abnormally low. It may very well just be that one institution puts a different emphasis on specific metrics. For example, one bureau might weigh something like medical collections higher or lower than another. But with that in mind, there are several common issues that are often the underlying cause of a lowered credit score.
You Have Late or Missing Payments
Late or missing payments are one of the most obvious explanations for an unexpected drop in credit scores. It’s easy for bills to get lost in the shuffle of everyday life. People accustomed to physical bills might not notice an emailed invoice. People used to digital payments might not notice a physical invoice mixed in with their junk mail. And of course, sometimes people simply put a bill aside for later and forget about it. But whatever the reason, missing payments can hurt your credit score. At the same time, paying off your bills can help you improve and protect your credit score.
You Recently Applied for a Mortgage, Loan or New Credit Card
Working with lines of credit is just a part of modern life. But it’s important to keep in mind that doing so involves actions and corresponding reactions. Applying for new lines of credit will of course necessitate inquiries into your creditworthiness. By giving lenders the authority to look into your credit history you’re allowing for something known as a hard inquiry.
Hard inquiries are a natural part of working with the modern financial system. But too many hard inquiries in a short amount of time can negatively impact credit scores. This is especially important since the impact of frequent hard inquiries can last for up to two years. And people who wonder how often does your credit score update discover that changes happen far more often than they might expect. The impact of too many hard inquiries can occur fairly quickly. And they can linger for some time afterward.
Your Credit Utilization Has Increased
People are often advised to use their credit cards to boost their credit score. However, it’s important to keep in mind that credit cards can both help and hinder your score. This is largely dependent on something known as a credit utilization rate. This ratio refers to how much credit you’ve used on your card in relation to its total credit limit. For example, if you had a balance of $100 on a card with a $10,000 credit limit then you’d have a 1% credit utilization ratio.
Low utilization shows lenders that you have a history of paying off your purchases. People are usually advised to keep their credit utilization ratio under 30% in order to avoid lowering their overall credit score. However, Forbes points out that you can actually improve your credit score and build credit by keeping your ratio at or close to 0%.
One of Your Credit Limits Decreased
It’s important to keep in mind that the credit utilization ratio is tied to an account’s credit limit. If your credit limit goes up then your overall usage ratio would go down. But if your credit limit decreases then your utilization ratio will go up. Consider the earlier example of a card with a balance of $100 and total limit of $10,000. The ratio seen there is just 1%. But if the credit limit was lowered to $1,000 then that same $100 balance would result in a 10% utilization ratio.
Someone might wonder why did my credit score drop after paying off debt balances. But in this case, it’s important to keep in mind that ratios and percentiles are often just as important as firm numbers. The same debt can have a different impact on your credit score depending on the total credit limit.
You Closed a Credit Card
You’re far from alone if you’ve seen your credit score drop while you were trying to improve your financial situation. It’s quite common for people to close secondary credit card accounts when they’re working on their finances. And they often wonder why their credit scores dropped while they were in the process of solidifying credit lines. The answer in this case once again comes back to credit utilization. Your credit utilization can apply to multiple accounts. Closing one credit card will then remove its credit limit from the total calculation. This has an end effect of raising the total utilization ratio.
On top of this, the importance of an account is often tied to its age. Older accounts will generally have a stronger positive impact on your overall credit score due to their longer payment history. An old card can attest to a long history of on-time payments. Your credit score might drop when those older accounts are closed.
There Is Inaccurate Information on Your Credit Report
At this point, you’ve seen that credit scores are calculated through solid and predictable logic. This is why it’s a good idea to look into your credit report when there doesn’t seem to be any logic behind significant drops in credit scores. Directly going through it will let you search out any obvious problems or discrepancies. This will typically come in the form of inaccurate information. It could even be a simple mistake.
While rare, attribution errors and the like can occur. But identity fraud is a more easily noticed problem. Someone using your identity without your knowledge can create a variety of issues for your overall credit score and a victim of identity theft can have a lot of work ahead of them to try and rectify the damage the fraudster did. No matter where the problem comes from, if you notice incorrect information you need to take action to rectify it with the proper bureaus.
You’ve Experienced a Major Event Such as Foreclosure or Bankruptcy
Major financial issues such as bankruptcy or foreclosure will have a huge impact on credit scores. Foreclosures can have a negative impact on credit scores for up to seven years. Different types of bankruptcy can impact people’s credit scores for differing lengths of time. For example, Chapter 7 bankruptcy has a duration of up to ten years. While Chapter 13 can impact credit scores for up to seven years. On top of this, both events tend to coincide with a large number of late payments. All of these issues can snowball into unexpected drops in credit scores that last far longer than many people anticipate.
A Recent Hard Inquiry
You’ve seen that applying for new lines of credit can result in lowered credit scores. When you authorize someone to check your credit history you’re allowing a hard inquiry. This typically only results in a small impact on credit scores. But it’s a small impact that can last for up to two years. Hard inquiries are a natural part of working with credit. And their overall impact is generally fairly minor. But it can be enough to explain some overall drop in credit scores.
What is a Hard Pull vs a Soft Pull?
A hard pull is when you apply for a new loan or credit card and your creditors will thoroughly investigate your credit history to ensure you are a suitable candidate for credit.
A soft pull occurs when checking your credit history yourself or having a credit card company or lender check your credit history to see if you are eligible for a loan or credit card.
When completing a Pool Loan Application with Viking Capital we do a soft pull to check your eligibility which means it does not hurt your score in any way.
Should You Worry About Your Credit Score Dropping?
A low credit score is a serious matter. However, it’s important to remember that these numbers are always in flux. A perceived drop might simply come from seeing the result of two different calculations. Even two credit scores from the same bureau, requested at the same time, might be significantly different.
How To Improve Your Score
Working on credit score improvements is as important as preventing drops. Most of the logic behind explaining drops in credit scores also applies to improving them. For example, you can build good credit and avoid drops by ensuring a solid track record for your payments. You can leverage credit history by keeping older credit cards active and paid off. In general, actions that show that you pay back borrowed funds will help you improve your score.
Taking Control of Your Credit Score
Finally, it’s important to remember that asking why did my credit score drop for no reason isn’t just about finding a specific answer. The question also highlights how you can work with and plan for your financial future. All of the reasons why credit scores can drop also suggest how to improve them.