When you check your credit score and realise that it has declined, it can be scary and disappointing. What caused the sudden shift?
While you may be confused, there are various reasons why your score may have dropped. The first thing to understand is that credit scores are not static numbers. Rather, they are constantly changing and are updated around once a month. There are numerous factors that affect whether they go up or down.
- You made an application for one or more credit accounts.
- Your credit limit has been decreased.You’re carrying a balance.
- You deactivated a credit account.
- You paid your bill late.
- You paid off your debts.
- Your credit reports include an error.
- Your identity could be compromised.
- Your credit reports have problems.
What happened to my credit score?
Your credit score can fluctuate due to a variety of variables, which we’ll discuss below.
But first, understanding what makes up your scores can provide insight into how they work, giving you a clearer grasp of how and why they vary over time. For example, FICO credit scores, which are used by many lenders, are determined by:
Payment history (35%): This is the most heavily weighted criterion and shows whether a borrower has made on-time payments in the past.
Amounts owed (30%): This is the total amount of debt you hold. Lenders view high loan balances relative to credit restrictions as a risk.
Credit history duration (15%): The length of time you’ve had accounts open can effect your credit score, therefore the longer the better.
New credit (10%): Applying for multiple new credit accounts at once may harm your credit and make you appear riskier.
Some activities will have a greater impact on your credit score than others. However, this does not mean that some of the lower impact activities will not result in a decrease in your score. Let’s look at some of the most prevalent reasons why your credit score may have decreased.
- You applied for one or more credit accounts –
When applying for any type of loan, a credit check is usually performed to establish if the borrower is a qualified candidate. When you apply for a mortgage, credit card, or personal loan, you will receive a hard inquiry on your credit report for two years.
In general, this may result in a few points being reduced from your credit score, but it will usually return after a few months. In some cases, your credit score may even rise a few points. When you open a credit card, for example, your total credit limit increases, lowering your credit utilisation or “amounts owing.”
This effectively shows that you have more accessible credit but are using a smaller amount of it, which is appealing to lenders.
While asking for a single loan or line of credit may have a minor impact on your credit score, applying for many credit accounts or loans is a different story. Borrowers who apply for multiple loans in a short period of time may raise a red signal for lenders and be viewed as a risk.
This can have an effect on your “new credit” and lower your credit score. Lenders are looking for borrowers who can repay their loans. Taking out multiple loans might result in higher monthly payments and be an indication of financial insecurity or danger.
But how much is too much? According to Equifax, one of the three credit bureaus, customers should have two to three credit cards in addition to another type of loan. This could be a mortgage or student loan, for example. This would increase your overall “credit mix,” which could boost your score. - Your credit limit was reduced –
When you are authorised for a credit card, you are given a credit limit that is based on the information you submitted during the application process. Over time, your lender may decide to increase or decrease the credit limit it initially provided to you.
Your credit use ratio will be affected if your credit limit is reduced. “Lowering your credit limit reduces your credit usage ratio, which is your total outstanding debt on all accounts divided by your total credit limit on all accounts,” Avanti Shetye, CFA, founder of Foolproof Financial Freedom, explains.
Even if you charge the same amount on your credit card each month, you’re now utilising a bigger percentage of available credit because your limit is lower. This may result in a worse score based on “amounts owing.”
So, what caused this? There are various causes for this, including a change in the economic climate or using too little or too much of your credit limit.
If this happens to you, call your credit card company right away to see if the old limit can be reinstated. If not, work on paying down debts. To avoid this problem totally, you should attempt to use your card consistently and wisely. - You have a balancing act –
There is a widespread and detrimental misunderstanding that holding a balance is beneficial to your credit. That is not only incorrect, but it can cost you more in interest over time, increasing the cost of borrowing.
The main reason that having a balance may affect your credit score is your credit use ratio.
Credit cards with high balances that are close to the limit are viewed as dangerous by lenders. As a result, it is advised that borrowers keep their credit use under 30%.
To calculate your credit utilisation ratio, divide your credit card balance by its limit ($6,000 in this case).
1,000/6,000 = 0.1666
Multiply by 100: This will convert the decimal to a percentage.
0.1666 x 100 = 16.66
Your credit usage is 16.66%, which is healthy and matches the recommendation of less than 30%. However, there is one unseen factor influencing consumer credit consumption right now: inflation.
“What we’ve seen over the last six months is that stimulus balances and deposits have decreased, while credit card utilisation and balances have increased,” says Dr. David Tuyo, CEO of University Credit Union. “What’s interesting about this is that people aren’t spending more money; we’re really seeing high inflation strike ordinary transactions.” They’re still doing the same thing; their behaviour hasn’t changed, nor has the risk, but their balances are rising due to inflation, which is lowering their score. “
If inflation affects your credit card balances or an unforeseen need develops, your credit utilisation may surpass the suggested 30%.
If you have a $2,500 balance, your credit usage will increase by 41.6% (2,500/6,000 = 0.416 x 100 = 41.6%).
According to the FICO methodology, “amounts owed” account for 30% of your credit score, making it a key component in why your credit score may be poor.
- You cancelled a credit card –
Whether you close a credit card because you’re in debt, to avoid paying an annual fee, or to simplify your finances, the decision may have an influence on your credit score. This has an effect on your credit score’s “length of credit history” as well as credit use, and may lower it.
Longer credit history benefits accounts that have been open for a long time. You can influence the average age of accounts by cancelling one account. The average age is calculated by dividing the number of accounts by the number of years they have been open.
Add the account ages (4+1+7 = 12), then divide the total by the number of accounts (12/3 = 4), which is the account average.
As a result, closing your one credit line can harm your credit score. The good news is that cancelled accounts will remain on your credit report for 10 years if you kept the account in good standing and made payments on time. - You paid your bill late –
When it comes to the components that influence your credit score, your payment history has the largest influence (35%). Lenders value regularity and dependability. If you skip a payment, your credit score will suffer.
However, it depends on whether this is a one-time occurrence or a recurring occurrence, as well as how long it has been since you missed your payment.
“A single missing payment causes a yo-yo effect,” Tuyo explains. “After 30 days, your score drops and then rises again.” However, once you reach 60 and 90 days, you have entered what is known as “serious delinquency.” As a result, the score will fall and begin to trend downward. So, if you have many missing payments, it is now considered “substantially delinquent.”
If you pay late, you may be charged late fees and interest, as well as have your credit score affected. However, time is also critical. You may be able to get ahead of the problem if you can resolve it before the activity is reported to the credit bureaus. Late payments may not be reported for 60 days after the due date, according to credit bureau Equifax.
When a late payment is reported, it might stay on your credit report for much longer. That single missed payment, a blip in time, can remain on your credit report for up to seven years. - You paid off your loan –
Assume you have finally paid off a debt, such as a credit card or personal loan. You’re ecstatic about your accomplishment—until you check your credit score and discover that it has really decreased. This is an unexpected scenario for those attempting to pay off debt, such as students repaying student loans.
“When a student loan, which is normally paid off in instalments as opposed to credit card debt, is removed from the credit mix, your score suffers a brief drop,” Shetye notes. “By reducing one sort of debt, lenders regard you as a hazardous borrower with a reduced ability to manage many types of debt.”
Paying out a loan and closing an account may also have an impact on the duration of your credit history and, consequently, your credit utilisation.
While it can be discouraging to accomplish something significant like debt repayment just to see your credit score sink, this is usually a temporary issue. In a few months, you may see an improvement in your score.
Borrowers should not be concerned about the brief drop in credit scores. Instead, they should put what would have been their student loan payments toward other goals, such as investing, says Shetye. - There is an error on your credit reports –
Because mistakes might happen, it’s always a good idea to review your credit reports on a frequent basis. In fact, according to a 2013 Federal Trade Commission (FTC) survey, one out of every five consumers had a credit report inaccuracy.
For example, you may find that an account is not correctly updated or that the credit limit is incorrect. Such errors, particularly in payment, might have a negative impact on your credit score. When reading your credit report, if you detect any mistakes, contact the credit agency and register a dispute.
You can examine your credit report and sign up for credit monitoring to be notified about changes in your accounts to keep track of your credit report and avoid credit report problems. - Your identity may be compromised –
Identity theft is another cause for concern because it might harm your credit. Assume someone obtains your personal information and uses it to open a credit card in your name, piling up a bill.
Because this is a new inquiry, it may have an effect on your credit. If the fraudster charges close to the limit, this can have a negative impact on your credit utilisation. Finally, late payments on the account can be costly.
Unbeknownst to you, identity theft could cause your credit score to plummet. If you are a victim of identity theft, go to IdentityTheft.gov to report the crime and make a plan for moving ahead.
You can also set up a fraud alert with Equifax, Experian, and TransUnion, the three major credit agencies. Credit monitoring may also assist you in staying on top of credit activity so that any questionable activity can be flagged. - Your credit reports include flaws –
While some other reasons for your credit score reduction may be less visible, if you have blemishes on your credit report, there are more clear credit repercussions.
For example, you may have “derogatory” marks on your credit report. These are examples:- Bankruptcy: Debt discharge through bankruptcy can have a long-term influence on your credit. “Depending on the sort of bankruptcy, a bankruptcy will likely remain on your credit report for seven to ten years,” Shetye explains. “And, while bankruptcy can almost quickly wipe out your debt, you’ll be seen as a hazardous borrower for a long time.”
- Liens: A lien secures the legal right to a specific asset that can be used to secure a debt. A mortgage lien, for example, gives the lender the right to recoup costs and confiscate someone’s home if they fail to make mortgage payments. Tax liens are no longer reflected in credit reports as of 2018. Liens, according to Experian, are not on your credit reports, but missed payments may be and harm your score.
- Foreclosure: If you fail to make your mortgage payments, you may face foreclosure. The lender takes ownership of the home as collateral in this process to collect the cost of missing payments. This could appear on your credit report for up to seven years.
- Suits and judgments: According to the Consumer Financial Protection Bureau (CFPB), lawsuits and judgments can remain on your credit record for up to seven years.
- Bankruptcy: Debt discharge through bankruptcy can have a long-term influence on your credit. “Depending on the sort of bankruptcy, a bankruptcy will likely remain on your credit report for seven to ten years,” Shetye explains. “And, while bankruptcy can almost quickly wipe out your debt, you’ll be seen as a hazardous borrower for a long time.”
Default on student loans Borrowers with federal loans who do not make monthly payments for 270 days are in default. According to the CFPB, this term is only 90 days for private student loans. Defaulting on a loan can have a negative impact on your credit score for up to seven years.
Source: Fortune.com