Noticing an unexplained significant dip in your credit score can cause you to panic. And with good reason because having and maintaining a good credit score is a big deal for your financial life.
What is a credit score?
A credit score is a three-digit number usually from 300 to 850 that lenders use to predict your behavior as a borrower. It is used to decide whether or not you are eligible for credit facilities like mortgages, loans, credit cards, etc. The higher your score, the more financial advantages, considerations, and options you have.
With a credit score of 740 and above, you can get prequalified or preapproved for car insurance or mortgage by your lender, qualify for lower interest rates, and take advantage of the best introductory offers and reward incentives on new credit cards, among other perks.
A low credit score on the other hand, which is anywhere from 669 and under, comes with several disadvantages like trouble getting approved by lenders and outrageous interest rates upon approval.
Reasons why your credit score dropped
You paid off debt on a credit account and closed it.
Paying off your debt is a good thing and can improve your credit score in the long run. However, where you close the account it reduces your credit score by increasing your credit utilization ratio.
Your credit utilization ratio shows how much of your available credit you are using. Experts recommend a 30% credit ratio threshold.
For example, if you have a credit card limit of 20,000 and a personal line of credit of 10,000. Your total credit limit is 30,000.
If you have a credit card balance of 7,200 your credit utilization ratio is 24%. If you choose to close your line of credit your utilization ratio will go from 24% to 36%.
You closed a longstanding credit account
When you pay off longstanding credit account that you don’t want to use anymore, your first point of call may be to close it.
And while you shouldn’t keep a credit account open just to benefit your credit score, you should know that closing it will impact your score negatively.
For example, say you have four credit accounts, and they have been open for two, six, eight, and twelve years, your average credit account age is seven years. If you decide to pay off your balance on the twelve-year account and close it, your average account age will drop to 5.3 years causing your credit score to drop.
How to fix it: If you have already paid off your debt and closed the account, there’s nothing you can do to reverse it. Instead put your energy towards rebuilding your credit.
You skipped a payment.
Your payment history is the most influential factor in your FICO score. A single missed payment can result in a significant dip.
This might be puzzling if you keep track of your debt and have a good repayment schedule. However, if you’ve noticed a dip in your credit score, it is worth reviewing your payments to see if you missed anything.
If you confirm that you skipped a payment, address it quickly as missed payment can damage your score even more, 60 to 90 days past the due date.
How to handle a missed payment: Contact your lender and explain your circumstances. If you’re in luck your lenders will oblige you and remove the late payment from your report and also waive the late fee.
If they don’t, the late payment report will stay on your credit report for seven years. Although, its effect on your credit report will reduce as time goes by.
Your lender made an inaccurate entry on your credit report
Your creditor might have given the credit reporting agencies inaccurate information on your account. If it’s negative, it will cause your score to take a dip until you dispute it and have it removed
How to deal with a mistake on your credit report: Go over your credit report for inaccuracies and file a dispute along with documents supporting your claim with the credit bureaus.
Your Credit utilization ratio increased.
Your credit utilization ratio accounts for 30% percent of your Fico score. It is the percentage of your available credit you are using at a given time. For example, a credit card with a limit of 100,000 and a balance of 20,000 has a 20% utilization rate.
Although Fico doesn’t state a threshold where your ratio starts hurting your credit, experts agree it should be below 30%. So anything from 0% to 27% is good for your credit score.
Some reasons why your credit ratio has increased
- Your credit issuer has reduced your limit; from the example above, if your limit is slashed in half and becomes $50,000 it puts your credit utilization ratio at 40%, 10% above the recommended threshold.
- You increased the balance on your credit account; if you make a massive purchase using your credit card, it will affect your credit utilization ratio. From our first example, say your limit remains at 100,000 and you make a purchase worth 16,000 in addition to the first balance of $20,000 you would now have a credit balance of 36,000 which takes your credit utilization ratio to 36%.
- You’ve closed one or two credit accounts.
How to reduce your credit utilization ratio:
- Negotiate an increase in your credit limit with your lender.
- Pay down your credit balance.
- Avoid closing old credit card accounts unless there is an annual fee or security deposit or you are having issues with overspending.
You applied for multiple credit cards.
Every time you apply for a new credit card or credit product your lender carries out a hard inquiry on one more of your credit reports. Each inquiry knocks off no more than five points from your credit score for one year.
If you apply for multiple credit cards or products at once, each lender will carry out their hard inquiry. If 10 inquiries are conducted on your credit report then 50 points in total will be deducted from your credit score for a year.
Although, If you’re rate shopping for an auto loan, mortgage, or student within a 15-45 day period, FICO counts it as one hard inquiry.
In addition to hard inquiries, a new credit account could also reduce the average age of your credit accounts causing a dip in your credit score.
How to fix it: Rate shop within 45 days so your hard inquiries add up to one and apply for credit only when needed.
Your identity has been stolen.
If you notice a dent in your credit card score and a credit balance you do not recognize, your credit information may have been stolen.
Once this is confirmed you need to act fast because if the thief gains access to your social security number and full name, they could open a credit account in your name.
How to handle credit information and identity theft:
- Scrutinize your credit for unauthorized accounts
- If you find fraud, file a police report and an identity theft report with the federal trade commission
- Notify the credit bureaus and your creditor
- Place fraud alerts on your credit reports
- Consider freezing your accounts.
Your medical bill has been sent to collections.
If you have medical debt that has gone unresolved for 180 days that may be the reason your credit score has dropped.
Generally, medical debt does not impact your credit score unless it is sent to collections. Your healthcare provider may send your bill to collections 30, 60, or 90 days after the due date.
However, Federal law requires collection agencies to wait 180 days after the due date to report the account to credit bureaus.
How to deal with your medical bill being sent to collections:
Pay off the debt as soon as you can. Once it’s cleared, it will be removed from your credit report.
You cosigned a loan or, you’re an authorized user.
If you cosign a loan, or are an authorized user on someone else’s credit account, those accounts will show up on your credit report. Meaning, any negative remarks or missed payments on those accounts will reflect on your report.
How to fix it: Try to convince the person to refinance the loan without you to prevent further damage. If you’re an authorized user, request to be removed from the account and it won’t show up on your credit report.
You are unaware that there is a default judgment against you
A default judgment occurs when you don’t respond to a lawsuit against you and the judge decides in your absence.
Some reasons you may be unaware of the default judgment include a sewer service where the person intentionally fails to inform you of the lawsuit and misdelivered letters or letters not being forwarded properly.
Whether you are aware or not, the default judgment will appear on your credit report causing a dip in your credit score. It would affect your report for five years unless it is removed.
How to deal with a default judgment on your credit report:
- Challenge the judgment – if you do not owe the debt claimed, gather your supporting documents, consult an attorney, and challenge it.
- Accept and settle the judgment – if you actually owe the creditor, you can pay the debt amount or reach an agreement to pay a reduced amount.
- When you pay the judgment sum ask the creditor to notify the court of your payment, so the court can notify the credit agencies and they can remove the default judgment from your record.
You have a mixed credit identity.
You have a mixed credit identity when someone else’s credit information or accounts have been comingled with yours.
As a result, that person’s credit balance, payment history, and credit accounts will show up on your credit report. If they max out their credit, it could increase your credit utilization ratio. If they consistently miss payments, your credit score will take a hit.
Some reasons for a mixed credit identity include data entry errors, family members with the same name, different ways of spelling your name, name changes, and identity fraud.
How to fix it: Notify all the credit bureaus where you have a mixed credit file and submit documents supporting your claims. The bureaus are required by the Fair Credit Reporting Act to investigate your claims.
Also, notify the creditors that entered the wrong information informing them of the mistake. Like the credit bureaus, they also have a duty to investigate your claims and correct mistakes if they find any.
Why has my credit score reduced?
Although it may seem like your credit score has dropped without reason, note that credit scoring systems use complex algorithms to calculate your score. Meaning, when your score changes, there has been a change in the information used to determine the score.
The change can be as subtle as a hard inquiry for a new credit application or as severe as identity theft. Whatever the case, there is always a reason for a change in your credit score.
However, to avoid surprises always monitor and review your credit reports. As they say, the devil is truly in the details.