Why Do Credit Scores Drop? Key Reasons for a Lower Score
Understand the core dynamics behind credit score fluctuations. Learn the common and less common reasons your score may unexpectedly decline.
A credit score is a numerical summary representing an individual’s creditworthiness. This three-digit number, ranging from 300 to 850, helps lenders assess the likelihood of an applicant repaying borrowed funds. Credit scores are dynamic and fluctuate, updating at least monthly as lenders report new information to the major credit bureaus: Equifax, Experian, and TransUnion.
Payment Behavior Changes
Payment history holds significant weight in credit score calculations, comprising 35% of a FICO score. Any deviation from timely payments can lead to a decrease in a credit score. A single late payment, even 30 days past due, negatively impacts a score. The impact increases with payment lateness, with 60-day or 90-day delinquencies causing more damage.
Accounts that go into collections or are charged off represent payment defaults and can harm credit scores. A collection account indicates a debt sold to a third-party agency due to non-payment. A charge-off occurs when a creditor considers an account uncollectible and writes it off as a loss, though the debt may still be pursued. Both derogatory marks remain on a credit report for approximately seven years.
Public records, such as bankruptcies and foreclosures, can lower a credit score. A bankruptcy filing can cause a score drop, potentially by 130 to 240 points for individuals with higher initial scores. The type of bankruptcy determines how long it remains on a credit report; Chapter 7 bankruptcies stay for 10 years, while Chapter 13 bankruptcies remain for seven years.
Similarly, a foreclosure signifies a failure to meet mortgage obligations and can lead to a credit score decrease of 100 points or more, particularly for those with strong credit histories. A foreclosure remains on a credit report for seven years from the date of the first missed payment. While these events have a lasting effect, their negative influence diminishes over time.
Credit Usage and Account Dynamics
The credit utilization ratio, the amount of credit used relative to total available credit, is a significant factor influencing credit scores, accounting for about 30% of a FICO score. A higher utilization ratio suggests a greater reliance on borrowed funds, which lenders may view as an increased risk. Maintaining a credit utilization ratio below 30% is recommended.
If a credit card balance remains high or increases relative to the credit limit, the utilization ratio rises, which can cause a credit score to decline. This impact can be immediate once the account balance is reported. Conversely, reducing balances can positively affect the score as soon as lower utilization is reported.
Closing older, established credit accounts can negatively affect a credit score. Such actions shorten the overall length of credit history. Closing an account also reduces total available credit, which can inadvertently increase the credit utilization ratio if existing balances are not simultaneously paid down. For instance, if a card with a $5,000 limit and a zero balance is closed, total available credit decreases, potentially pushing up the utilization ratio on remaining cards.
A lender reducing a credit limit can impact a credit score, even if spending habits do not change. When a credit limit is lowered, the existing balance immediately represents a larger percentage of the newly reduced limit. This increase in the utilization ratio can lead to a score drop. For example, a $250 balance on a $1,000 limit is 25% utilization, but if the limit is halved to $500, the same $250 balance becomes 50% utilization, potentially causing a score decline.
Impact of New Credit and Inquiries
Applying for new credit can temporarily lower a credit score due to a “hard inquiry.” A hard inquiry occurs when a lender checks an individual’s credit report as part of a loan or credit card application. This inquiry signals to other lenders that an individual is seeking new credit, which can be interpreted as an increased risk.
A single hard inquiry causes a small, temporary dip in a credit score, often by fewer than five points. These inquiries can remain on a credit report for up to two years, though their impact on a FICO score diminishes after 12 months. A “soft inquiry” does not affect a credit score. Soft inquiries occur when an individual checks their own credit or a lender pre-screens for promotional offers.
Opening multiple new credit accounts within a short timeframe can be viewed as risky by lenders and contribute to a score drop. This behavior may suggest an increased reliance on credit or potential financial distress. While one or two applications may have a minimal effect, a series of applications over a short period can have a cumulative negative impact.
An exception exists for “rate shopping” for specific loan types, such as mortgages, auto loans, or student loans. Credit scoring models count multiple inquiries for these loan types within a concentrated period, 14 to 45 days, as a single inquiry. This allows consumers to compare loan terms from different lenders without penalizing their score for each individual inquiry. This exception does not apply to credit card applications.
Unexpected Issues
Credit scores can drop due to issues like identity theft or errors on a credit report. Identity theft can lead to fraudulent accounts or unauthorized charges. When an identity thief opens new lines of credit in someone else’s name and fails to make payments, these delinquent accounts or increased credit utilization ratios can harm the victim’s credit score. Resulting hard inquiries from fraudulent applications further contribute to a score decline.
Errors on a credit report can impact a credit score negatively. These inaccuracies might include incorrect late payment notations, accounts that do not belong to the individual, or outdated negative information. Such errors can misrepresent an individual’s financial behavior and lead to an undeserved score reduction.
Individuals can dispute inaccurate information found on their credit reports with the credit bureaus. Promptly identifying and correcting these issues helps restore an accurate credit score. If identity theft is suspected, reporting it to the Federal Trade Commission and credit bureaus helps mitigate damage and initiate recovery.