Why Does a Credit Score Go Down?

A credit score is a numerical summary reflecting an individual’s creditworthiness. It serves as a prediction of how likely someone is to repay borrowed funds on time. Understanding the specific events that cause these changes is important for managing financial health.

Understanding Credit Score Fundamentals

Credit scores are built upon several categories of financial information, each contributing to the overall assessment of credit risk. These categories, weighted differently by various scoring models, generally include payment history, amounts owed, length of credit history, new credit, and credit mix. Lenders use these scores to make decisions regarding loan approvals, interest rates, and credit limits.

Payment history is typically the most influential factor, indicating whether past credit accounts have been paid on time. This includes details on credit cards, loans, late or missed payments, bankruptcies, or accounts sent to collections. Scoring models analyze how often payments were late, by how much, and how recently.

Amounts owed, or credit utilization, represent the proportion of available credit currently being used. Keeping this ratio low, ideally below 30% for revolving credit, is favorable. High credit utilization can suggest an individual is overextended financially.

Length of credit history considers how long accounts have been established, including the age of the oldest account and the average age of all accounts. A longer history of responsible credit management is viewed positively. This factor indicates stability and experience in handling debt over time.

New credit activity, such as recent applications, accounts for a smaller portion of the score. Applying for new credit results in a “hard inquiry” on a credit report, which can temporarily lower the score. Opening multiple new accounts in a short period may signal increased risk.

Credit mix refers to the diversity of credit types an individual manages, such as revolving credit (like credit cards) and installment loans (like mortgages or auto loans). Demonstrating the ability to handle different forms of credit responsibly can contribute positively to a score. While having a diverse mix can be beneficial, it is not necessary to have every type of credit.

Common Reasons for a Score Decrease

A credit score can decrease for several reasons, signaling increased risk to lenders. Understanding these impacts can help individuals manage their financial behavior more effectively.

Late or missed payments are a frequent cause of score drops, as payment history is a heavily weighted factor. A payment reported 30 days or more past its due date can significantly impact a score. The later a payment becomes, the more severe the negative effect. Even a single late payment can cause a substantial decrease, and these negative marks can remain on a credit report for up to seven years.

Increased credit utilization, where a higher percentage of available credit is used, can lead to a score reduction. Maxing out credit cards or approaching credit limits suggests a higher reliance on borrowed funds. Lenders prefer credit utilization ratios below 30%, as exceeding this threshold can indicate financial strain.

New credit applications result in a “hard inquiry” on a credit report, which can cause a temporary dip in the score. While a single inquiry usually has a minor effect, numerous applications within a short timeframe can be viewed as increased risk. These inquiries typically impact the score for about a year, though they may remain on the report for two years.

Closing old credit accounts can inadvertently hurt a credit score. This may reduce total available credit, increasing the credit utilization ratio if balances are maintained. Closing older accounts can also shorten the average length of credit history.

Public records, such as bankruptcy, foreclosure, or tax liens, have a severe and prolonged negative impact on credit scores. A bankruptcy filing can drastically lower a score. A Chapter 7 bankruptcy can remain on a credit report for up to 10 years, and a Chapter 13 filing for up to seven years.

Accounts sent to collections or charged off by a creditor significantly harm a score. When a debt becomes severely delinquent, a creditor may sell it to a collection agency or write it off as uncollectible. Both actions are negative entries on a credit report and indicate a failure to repay debt.

Identity theft or fraud can lead to a score decrease if unauthorized accounts are opened or existing accounts are misused. Thieves may open new credit lines, incur debt, and fail to make payments, resulting in negative entries. This fraudulent activity can lead to hard inquiries, increased utilization, and missed payments, all of which lower a score.

How to Identify Score Changes

When a credit score drops, identifying the cause involves reviewing detailed financial information. This process focuses on pinpointing the event or activity that led to the change. Understanding how to access and interpret credit information is essential for diagnosing score fluctuations.

A primary step is to obtain free credit reports from the three major credit bureaus: Equifax, Experian, and TransUnion. Federal law allows consumers to receive one free report from each bureau annually through AnnualCreditReport.com. These reports contain comprehensive data that credit scoring models use, providing a detailed history of credit accounts and payment behavior.

Upon receiving credit reports, review them for discrepancies or unexpected entries. Look for new accounts not opened, late payments made on time, or unfamiliar collection accounts. Inaccurate personal information, incorrect account statuses, or high balances can also indicate issues.

Credit monitoring services can assist in tracking score changes and identifying potential issues. Many banks, credit card companies, and third-party providers offer these services, sometimes for free. These services provide alerts for significant changes on a credit report, such as new inquiries, opened accounts, or reported late payments. This proactive notification can help in quickly addressing suspicious activity.

If inaccuracies are found on a credit report, they should be disputed with the credit reporting company (Equifax, Experian, or TransUnion) and the company that furnished the information. Disputes can be filed online, by mail, or by phone. When disputing, clearly explain the error, provide supporting documentation, and keep records of all communications. Credit bureaus generally have 30 days to investigate a dispute.