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Credit scores change all the time, and sometimes it’s unclear why. Here’s a primer on the most common reasons credit scores take a sudden plunge and how you can prevent it from happening.
What is a Credit Score?
Your credit score is a three-digit composite of your financial history, specifically your habits around borrowing and repaying money. To have a credit score, you’ve opened accounts, borrowed money, and paid it back at some time in your life. Most people start with a low to average credit score and gradually increase over time.
Common Reasons for a Dropped Credit Score
Your credit score is dynamic, and you’ll experience periodic rises and falls throughout your lifetime. Here are a few of the most common situations that can cause your credit score to dip.
1. Recent application for new credit
When you apply for a new line of credit, like a mortgage, auto financing, or even just a new credit card, the lender will do a hard inquiry of your credit report. A hard inquiry grants access to your borrowing and payment history so institutions can decide whether or not to lend you money.
Most people have hard inquiries (also known as “hard pulls”) on their report, but having too many in a short period of time reads as a red flag. Lenders want to ensure you’re not taking out too much credit all at once, so be thoughtful about making requests that might trigger a hard pull. Hard inquiries fall off your report after two years.
2. Late or missed payments
Forgot to pay a bill last month? That may be the reason your credit score is taking a dive. Once you’re 30 days past the due date on a bill, institutions report the loss to credit bureaus. The good news is that if you pay off your overdue bill within 30 days, there’s no harm to your credit score.
We recommend setting up your monthly payments on auto draft — that way there’s no chance of forgetting! This is especially important because on-time payments count for more than 30% of your overall credit score.
3. Derogatory marks on your report
Major shifts in your financial status — like declaring bankruptcy, going into collections, or experiencing a foreclosure — can prompt a derogatory mark on your credit report from your lender. Unlike hard inquiries, derogatory marks stick around for quite some time: most will appear on your credit report for up to 7 to 10 years.
4. Higher utilization of credit
The second most-important factor in determining your score is your credit utilization ratio. If your limit is $10,000 and you have a balance of $5,000, you’re using 50% of your total credit limit.
Lenders see lower credit utilization ratios as evidence of responsible spending and the ability to pay off debt month over month. Aim to keep your ratio below 30% (even better if you can go below 10% total). If you’re running a balance that’s much higher, you may see the effects on your credit score — especially if you keep a high ratio month over month.
5. Closing a credit card
Here’s a common culprit of credit score drops: closing an old account. Lenders prefer accounts to stay active, even if they’re not carrying balances. Keeping old accounts open also ensures that your total credit limit stays higher, which helps your credit utilization ratio.
If you’re considering closing a credit card account, take this approach instead: set up a recurring monthly payment to the account to keep it active, and ensure the card is paid off every month.
6. Paying off auto and/or student loans
This one almost seems counterintuitive. You’d think that paying off large amounts of debt would help your score, right?
Lenders like to see a mix of credit, so when you pay off an auto loan or student loan, it’s not uncommon to see your credit score drop by more than a dozen points. This is because these loans are sizable, and once you pay them off, you’ve narrowed your credit mix and total credit limit. It’s still a best practice to responsibly pay off your loans, but keep in mind that this is a possibility once the accounts are paid in full.
7. Credit report inaccuracies
If you’ve crossed off all the other potential scenarios, it’s possible that there’s been a mistake made on your report by a lender or that you’ve experienced some form of fraud. If that’s the case, you’ll need to dispute incorrect information with the three major credit bureaus (Experian, Equifax, and TransUnion).
Keeping a close eye on your credit report throughout the year or investing in credit monitoring is a great way to ensure you know what kind of activity is being factored into your score.
Credit scores may change over time, but these precautions can help to minimize any dips along the way.
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