What Makes a Credit Score Drop? The Top 5 Factors

Credit scores serve as a numerical representation of an individual’s creditworthiness, indicating the likelihood of repaying borrowed money on time. These scores, typically ranging from 300 to 850, play a significant role in various financial aspects, influencing access to loans, credit cards, and even the interest rates offered. Credit scores are dynamic, meaning they can fluctuate based on ongoing financial behaviors and the information reported to credit bureaus. Understanding the factors that can lead to a decrease in a credit score is important for maintaining financial health.

Late or Missed Payments

Payment history stands as a primary determinant of credit scores, making up a substantial portion of scoring models. Even a single late payment can negatively affect a score, with the severity of the impact increasing with the degree of lateness. Creditors generally report payments as late to credit bureaus once they are at least 30 days past the due date.

The negative effect on a credit score becomes progressively more severe as payments become 60, 90, or more days overdue. Each subsequent reporting of a missed payment at these intervals further deepens the score reduction.

When accounts remain unpaid, they may eventually be sent to collections or charged off by the original creditor. A collection account indicates that the debt has been sold to a collection agency, while a charge-off means the creditor has deemed the debt uncollectible. Both of these are severe negative marks on a credit report.

These derogatory entries, such as late payments, collections, and charge-offs, can remain on a credit report for up to seven years from the date of the original delinquency. While their impact may lessen over time, especially with a subsequent history of on-time payments, they continue to signal increased risk to potential lenders.

Increased Credit Utilization

Credit utilization, also known as the credit utilization ratio, measures the amount of revolving credit currently being used against the total amount of revolving credit available. This ratio is calculated by dividing the total outstanding balances on revolving accounts, such as credit cards, by the total credit limits across those accounts. A higher utilization ratio is generally viewed negatively by credit scoring models, as it can suggest a higher reliance on credit or potential financial distress.

Credit scoring models consider credit utilization a significant factor, accounting for approximately 30% of a FICO score. Lenders typically prefer a utilization ratio of 30% or less. Exceeding this threshold can lead to a noticeable drop in a credit score, even if payments are consistently made on time.

Maxing out credit cards or using a large percentage of available credit on multiple accounts signals increased risk to lenders. Credit scoring models consider both individual card utilization and overall utilization.

Maintaining a high credit utilization ratio can make it more challenging to secure additional credit or obtain favorable interest rates. This is because it may indicate that an individual is either over-reliant on credit or is experiencing financial strain.

New Credit Activity

Applying for new credit can lead to a temporary reduction in a credit score due to what are known as hard inquiries. A hard inquiry occurs when a lender checks an individual’s credit report as part of a credit application process, such as for a credit card, auto loan, or mortgage. Each hard inquiry can cause a small, typically brief, dip in the credit score.

These inquiries signal to credit scoring models that an individual is actively seeking new debt, which can be interpreted as an increased risk, especially if multiple inquiries occur within a short timeframe. While a single hard inquiry usually has a minimal impact, applying for several new accounts in a brief period can lead to a more significant score decrease. Hard inquiries typically remain on a credit report for up to two years, though their impact on the score usually diminishes after 12 months.

Opening new credit accounts also influences the average age of all credit accounts. If an individual has a limited credit history, adding new, young accounts can lower the overall average age, which is a factor in credit scoring models. A shorter average age of accounts can be viewed less favorably by lenders, as it suggests a less established credit history.

Hard inquiries differ from soft inquiries. Soft inquiries, such as checking one’s own credit score or pre-qualifying for a loan, do not affect a credit score. These checks are typically performed without a specific credit application and are not indicative of seeking new debt.

Derogatory Marks and Public Records

Severe negative financial events, often referred to as derogatory marks or public records, can lead to substantial and long-lasting drops in a credit score. These marks include bankruptcies, foreclosures, repossessions, and civil judgments. Such events indicate significant financial distress and can be the most damaging factors to a credit profile.

A bankruptcy filing, particularly Chapter 7, can cause a dramatic decrease in a credit score and can remain on a credit report for up to 10 years. Chapter 13 bankruptcies typically remain for seven years.

Foreclosures and repossessions, which result from failure to make payments on secured loans like mortgages or auto loans, also severely impact credit scores. Both typically stay on a credit report for seven years from the date of the first missed payment that led to the event.

Civil judgments, which are court rulings against an individual for unpaid debts or other legal issues, historically appeared on credit reports and significantly impacted scores. However, since 2017, the three major credit reporting agencies no longer include most civil judgments on credit reports due to changes in reporting standards. While the judgment itself may not directly affect the credit score, the underlying unpaid debts that led to the judgment, such as late payments or collections, will still be reported and can negatively impact the score.