What Factors Make a Credit Score Drop?
Discover the key financial factors and reporting incidents that can lead to a lower credit score.
A credit score is a numerical representation of an individual’s creditworthiness. Lenders and creditors use this three-digit number to assess the likelihood of a borrower repaying debts on time. A higher score generally indicates a lower risk, potentially leading to more favorable loan terms and interest rates for mortgages, auto loans, and credit cards. A strong credit score can also influence approvals for apartment rentals, utility services, and even certain job offers.
Late or Missed Payments
Payment history is a primary determinant of a credit score, often accounting for a significant portion of its calculation. Even a single late payment can significantly impact a score, with the severity increasing the longer a payment is overdue. The impact increases with the duration of the delinquency, becoming more pronounced at 60, 90, or 120 days past due.
Creditors typically report payments as late to credit bureaus once they are 30 days past the due date. Its impact also depends on recency and credit history; a recent late payment is more damaging, and those with higher scores may see a greater drop. Delinquent payments can remain on a credit report for up to seven years from the original delinquency date.
High Credit Utilization
Another significant factor influencing credit scores is the credit utilization ratio, which measures the amount of credit being used against the total available credit. This ratio is calculated by dividing your total credit card balances by your total credit limits across all revolving accounts. A high credit utilization ratio, typically above 30%, negatively affects scores by suggesting higher reliance on borrowed funds and increased risk.
Maxing out credit cards or consistently carrying high balances can lead to a substantial drop in a credit score. Lenders may perceive such behavior as a sign of financial distress, even if payments are made on time. Conversely, keeping credit card balances low relative to credit limits demonstrates responsible credit management and can contribute positively to a credit score.
New Credit Inquiries and Account Changes
Applying for new credit often results in a “hard inquiry” on a credit report, which can temporarily lower a credit score. While a single hard inquiry has a minor impact, multiple inquiries in a short period signal higher risk and can lead to a more significant score drop. Hard inquiries usually remain on a credit report for two years, though their effect on a credit score typically diminishes after 12 months.
Opening new credit accounts also impacts the average age of all credit accounts, which is a component of credit scoring models. A new account lowers this average, potentially causing a slight initial reduction in a score, especially for individuals with a limited credit history. Conversely, closing older accounts, especially those with positive payment history, can negatively affect the average age of accounts and reduce total available credit, increasing utilization.
Serious Delinquencies and Public Records
Severe negative events on a credit report can profoundly and lastingly impact credit scores. A “charge-off” occurs when a creditor deems a debt uncollectible and writes it off as a loss, typically after 120 to 180 days of missed payments. This negative mark can stay on a credit report for up to seven years from the date of the first missed payment that led to the charge-off.
Accounts sent to collections also significantly damage credit scores. This happens when a creditor turns over an overdue debt to a third-party collection agency. Like charge-offs, collection accounts can remain on a credit report for seven years from the original delinquency date. More severe events, such as foreclosures and bankruptcies, have an even more detrimental effect. A foreclosure, resulting from missed mortgage payments, can lower a credit score significantly and remains on a report for seven years. Bankruptcy, the most severe event, indicates an inability to repay debts and causes a dramatic score drop, remaining on a credit report for seven to ten years depending on the type.
Credit Report Errors
Errors on a credit report can lead to an unexpected drop in a credit score. These inaccuracies can include incorrect late payments, accounts that do not belong to the individual, or incorrect balances and credit limits. For example, if a payment made on time is incorrectly reported as late, it can negatively impact the payment history component of a credit score.
Mistakes can also arise from identity theft, where fraudulent accounts appear on a report, or from data management errors, such as a mixed file where another person’s information is merged with yours. Regularly checking credit reports is important for identifying such discrepancies. While errors can be disputed with credit bureaus and the information providers, their presence can still affect creditworthiness until corrected.