What Causes Credit Scores to Suddenly Drop?
Why did your credit score suddenly drop? Understand the key factors and common causes behind unexpected score decreases.
A credit score is a numerical representation of an individual’s creditworthiness, providing lenders with an indication of the likelihood that a borrower will repay their debts. These three-digit numbers significantly influence various aspects of financial life, including the ability to secure loans, the interest rates offered, and even approvals for housing or insurance. Understanding the factors that cause these scores to fluctuate, particularly to decrease, is important for maintaining financial health. This article explores common reasons why a credit score might suddenly drop.
Payment Behavior
Payment history is often the most influential factor in credit scoring models, typically accounting for 35% of a FICO score. Even a single late payment can significantly impact a credit score. Creditors generally report payments as late only after they are 30 days past the due date. The severity of the score drop increases with the lateness of the payment (e.g., 60, 90, or 120 days past due) and the frequency of such occurrences.
Completely missing payments, leading to a default, can cause a more substantial decline in credit scores. When an account goes unpaid for an extended period, typically 90 to 180 days, the creditor may turn the debt over to a collection agency. A collection account appearing on a credit report indicates a severe delinquency and can severely lower scores. These collection accounts can remain on a credit report for up to seven years from the date of the original delinquency.
Major derogatory events, such as bankruptcies or foreclosures, represent the most severe negative impacts on credit scores. A Chapter 7 bankruptcy can remain on a credit report for up to 10 years, while a Chapter 13 bankruptcy stays for seven years from filing. These public records can cause a substantial decrease in a credit score, potentially over 100 points for those with high scores.
Credit Usage
Credit utilization ratio, the amount of credit used relative to total available credit, significantly affects scores, often contributing about 30% to a FICO score. It’s calculated by dividing total outstanding balances on revolving credit accounts by their total available credit limit. A high credit utilization ratio, generally considered to be above 30%, can signal increased risk to lenders and lead to a score decrease.
Maxing out credit cards is viewed negatively by scoring models. Even if payments are made on time, consistently high balances can indicate financial distress or an over-reliance on credit. Individuals with the highest credit scores often maintain credit utilization in the single digits, well below the 30% threshold.
Though all debt contributes to financial obligations, high balances on revolving credit, such as credit cards, impact utilization ratios more than installment loans. Installment loans, like mortgages or auto loans, have a fixed payment schedule with balances naturally decreasing over time. Consistently maintaining low utilization demonstrates responsible credit management, which is favorable for credit scores.
New Credit Applications and Account Changes
Applying for new credit can trigger a temporary drop in a credit score due to a hard inquiry. A hard inquiry occurs when a lender checks a credit report for a new loan or credit card application. Each hard inquiry can cause a small, temporary reduction of a few points in the score. While hard inquiries remain on a credit report for up to two years, they typically only affect credit scores for about 12 months.
Opening multiple new credit accounts within a short timeframe can be perceived as risky by credit scoring models. This behavior suggests a potential increase in debt and can also reduce the average age of credit accounts. The length of credit history accounts for approximately 15% of a FICO score, so a younger average age of accounts negatively impacts scores.
Conversely, closing an old, established credit account can negatively affect a credit score. This reduces total available credit, inadvertently increasing the credit utilization ratio if balances remain the same. Closing an older account also shortens the average age of credit history, potentially lowering the score. While closed accounts with a positive payment history may remain on a credit report for up to 10 years, their impact on average age of accounts can still be detrimental.
Credit Report Accuracy
Inaccuracies or fraudulent activity on a credit report can lead to an unexpected decrease in credit score. Incorrect information, such as a wrongly reported late payment, an unfamiliar account, or an inaccurate balance, can be factored into scoring models. These errors can cause the score to drop, even if finances are managed responsibly.
Identity theft or fraud can result in new, unauthorized accounts opened in one’s name or fraudulent charges on existing accounts. These activities are reported to credit bureaus as legitimate. For instance, a fraudulently opened credit card might show high utilization or missed payments, directly lowering the score.
Regularly checking credit reports from each of the three major credit bureaus is important for identifying and addressing discrepancies promptly. This proactive monitoring allows individuals to dispute inaccurate information, which helps prevent or mitigate negative impact on credit scores.