Why Does a Credit Score Drop? Common Causes

A credit score is a numerical representation of an individual’s creditworthiness. This three-digit number, typically ranging from 300 to 850, offers a snapshot of a person’s financial behavior. It influences a lender’s decision to extend credit, set interest rates, or approve loans like mortgages or auto financing. Understanding the factors that cause this score to fluctuate is important for managing one’s financial health effectively.

Late or Missed Payments

Payment history stands as a significant determinant in credit score calculations, often comprising about 35% of a FICO Score. A single payment made past its due date can negatively affect a credit score once it is reported to the credit bureaus. The severity of this impact generally increases with the duration of the delinquency.

A payment reported as 30 days late will have a noticeable effect, but a 60-day or 90-day late payment will cause a more substantial drop. Most late payments remain on a credit report for up to seven years from the date of the missed payment, although their influence on the score lessens over time.

When a debt remains unpaid for an extended period, it can lead to more severe negative entries like defaults or charge-offs. A default occurs after prolonged non-payment, often 90 days or more, indicating a failure to meet the financial obligation. A charge-off happens when a creditor determines an account is unlikely to be collected and writes it off as a loss, which also severely impacts the credit score. Both defaults and charge-offs remain on a credit report for up to seven years from the original delinquency date, signaling high risk to potential lenders.

High Credit Utilization

Credit utilization measures how much revolving credit is used compared to the total available credit. Lenders prefer a low credit utilization ratio, with many financial experts suggesting keeping it below 30% to maintain a healthy credit score.

Carrying high balances on credit cards, even if payments are made on time, indicates increased financial risk to lenders and can lead to a score drop. Maxing out one or more credit cards, meaning using 100% of the available credit, can have a particularly severe negative effect.

This concept primarily applies to revolving credit accounts, such as credit cards and lines of credit, where the borrower can repeatedly use and repay funds. It does not apply to installment loans, such as car loans or mortgages, where a fixed amount is borrowed and repaid over a set period. Reducing outstanding balances can help lower the credit utilization ratio, which can in turn contribute to improving a credit score.

New Credit Inquiries and Accounts

Applying for new credit, whether a loan or a credit card, usually results in a “hard inquiry” on a credit report. This occurs when a potential lender requests a detailed look at an individual’s credit history to assess their creditworthiness. Each hard inquiry can cause a small, temporary dip in a credit score, typically by a few points.

While a hard inquiry can remain on a credit report for up to two years, its impact on the credit score generally diminishes after about 12 months. Multiple hard inquiries in a short timeframe can signal to lenders that an individual might be seeking to take on a significant amount of new debt, which can be perceived as an increased risk. For instance, applying for several credit cards simultaneously can have a compounding negative effect.

Opening multiple new accounts in a short period also reduces the average age of an individual’s credit accounts. A longer average age of accounts is generally seen positively by scoring models, as it demonstrates a history of responsible credit management. Therefore, a reduction in this average can contribute to a score drop. It is important to distinguish hard inquiries from “soft inquiries,” such as checking one’s own credit score or pre-qualification offers, as soft inquiries do not affect the score.

Major Derogatory Events

Certain significant financial events are considered major derogatory marks and can cause substantial, long-lasting damage to a credit score. These events typically indicate severe financial distress and are reported to credit bureaus. Bankruptcies, for example, are legal proceedings that can profoundly impact credit.

A Chapter 7 bankruptcy can remain on a credit report for up to 10 years from the filing date, while a Chapter 13 bankruptcy typically stays for seven years. Foreclosures, which occur when a lender repossesses a property due to unpaid mortgage payments, can remain on a credit report for seven years from the date of the first missed payment that led to the foreclosure. Similarly, repossessions of vehicles or other assets due to loan defaults are reported and can stay on a credit report for seven years.

Accounts sent to collections, which happen when a debt is significantly past due and transferred to a collection agency, also have a severe negative impact. These collection accounts generally remain on a credit report for seven years from the original delinquency date of the debt. These types of events signal a high level of risk to potential lenders and can significantly hinder an individual’s ability to obtain new credit or favorable terms for many years.

Credit Report Errors or Identity Theft

Sometimes, a credit score drops due to inaccuracies on a credit report or identity theft, rather than an individual’s financial actions. Common errors include incorrect late payments, accounts not belonging to the individual, or inaccurate balances and credit limits that skew utilization. Duplicate accounts, where the same debt is listed multiple times, can also inflate reported debt. The Fair Credit Reporting Act (FCRA) provides consumers the right to dispute inaccurate information on their credit reports.

Identity theft is another cause of credit score drops. When a thief obtains personal information, they can open new credit accounts or make fraudulent charges. These unauthorized activities appear as new debts, missed payments, or high utilization on the victim’s report, severely damaging the score and hindering legitimate credit access. Regularly reviewing credit reports from Equifax, Experian, and TransUnion is important to identify and dispute such errors or signs of identity theft.