In many cases, a consumer who has seemingly been managing their finances responsibly will notice an unexpected credit score drop. This negative credit score fluctuation is particularly troubling for those concerned with maintaining good credit for an upcoming home or auto loan.

While your payment history constitutes the largest single factor that influences your credit score, certain lesser-known calculated variables and even actions that one would assume to be positive may actually cause an adverse impact.

Fortunately, many different strategies and accounts that build credit exist that allow for significantly improving your score. The following information will serve as valuable for avoiding many of these scenarios in the first place. 

8 Reasons Why a Credit Score Drops     

1. You Missed a Payment

Establishing a good payment history on credit accounts has a powerful and positive effect on your overall credit score. Consumers should expect that any payments that reach 30 days past due will be reported to the credit bureaus and will harm your credit.

Beyond 30 days, you should expect the adverse impact of a late payment to worsen at key intervals such as 60 and 90 days. Late payments and other negative events will remain on your credit report for seven years and hinder your score to some extent. 

2. Your Credit Utilization Increased                   

One of the well-known fundamentals, when either establishing credit for the first time or maintaining and improving an existing credit history, involves actual usage, such as by making a purchase using the available credit on a credit card account.

While developing a payment history is critical to achieving excellent credit, it may negatively impact your credit utilization ratio, which is often referred to as a credit utilization rate that uses the following formula:

Credit Utilization Ratio = current total debt (owed) / total credit limit (available credit)

For example: $2,000 in debt / $10,000 overall available limit = 20% credit utilization rate

Both the FICO and VantageScore models take a consumer’s credit utilization ratio into account when calculating scores. Lenders perceive consumers with high credit utilization ratios as potential credit risks, as they may be “overextended.”

According to Experian, credit utilization ratios of less than 30% are typically considered as good. Rates of under 10% are usually viewed as being outstanding; therefore, avoid using too much of your available credit limits.  

Utilization rates are among the reasons why “maxing out” a credit card is traditionally discouraged. 

To avoid this problem, borrowers should strive to pay off a large credit card purchase before the end of the billing cycle, or at least pay a significant amount of the overall debt.

Be sure to avoid confusing a credit utilization ratio with a debt-to-income ratio, which is expressed as the percentage of monthly debt relative to gross monthly income.

3. Your Credit Limit Decreased

The Consumer Financial Protection Bureau explains that credit card companies sometimes reduce the credit limit on an account. Depending on the size of the reduction, the corresponding decline in the overall available (maximum) credit may cause the utilization rate to spike. 

If a card issuer lowers your limit without notice, no penalties or fees for being over the limit may be imposed for a minimum of 45 days.

Throughout the repayment period, certain types of installment accounts including a mortgage loan, auto loan, or student loan factor into the overall available (maximum) credit limit amount used for calculating your utilization ratio.

Unlike a revolving credit card account that remains active or open if the balance reaches zero, these types of installment accounts will close when paid in full. This creates an increase in your credit utilization rate.

4. A Recent Hard Inquiry

Another commonly overlooked credit report entry that could cause an unexpected credit score drop is the presence of hard inquiries or “hard credit pulls” that indicate a consumer has recently applied for a new credit account.

When a consumer applies for a new credit line, the lender will access your credit report(s) to assess your creditworthiness. Evidence of this inquiry usually remains on your credit report for two years; however, only inquiries going back 12 months factor into your FICO score.

Lenders could also become alarmed when the credit report contains multiple recent inquiries for new credit accounts, which might indicate some potentially abrupt financial problems.

Per MyFICO.com, applying for several credit card accounts during a short time will generate multiple inquiries. Fortunately, most “rate shopping” for auto, mortgage, or student loans is combined into a single inquiry entry by the FICO algorithms.

Data from Transunion explained the concept of differentiating hard credit inquiries from “soft” credit inquiries. The term soft inquiry refers to a more routine credit check that is sometimes conducted by an organization that a consumer has an existing relationship with.

Businesses may perform a soft credit inquiry without first obtaining a consumer’s permission and these inquiries do not impact credit scoring. While both types create a credit report entry, only the consumer will view (see) their soft inquiries contained in a file.

5. Inaccurate Information on Your Credit Report

Consumers should regularly check their current credit bureau reports to assess their overall credit rating and look for any potential errors. Each credit reporting agency will provide you a free copy of your credit report that allows for reviewing your credit history.

Sometimes a bank, credit union, credit card issuer, or another lender might fail to properly report a personal loan, installment loan, or another new credit account that would help improve your credit profile and FICO credit score.

Checking your credit reporting company information is also a good practice for detecting potential fraud or identity theft. For example, someone might use your personal information to receive an unsecured credit card in your name and begin amassing major credit card debt.

After receiving a dispute, Equifax will investigate and report its findings within 30 days. TransUnion and Experian follow similar procedures. 

Equifax recommends that consumers filing a dispute gather the following groups of documentation:

• Personal information: Government-issued photo ID, birth certificate, and a utility bill or bank statement showing current address
• Existing types of credit accounts: Documentation regarding debts including student loans, credit cards, installment credit accounts, etc.
• Other documentation: Evidence of bankruptcy filings, canceled checks, and others.

6. You Closed an Account

Before formally closing an account such as closing a credit card, consider the potentially adverse impact on your FICO score.

The main concern involves closing an older credit account and reducing your overall length of credit history. The length of your credit history is based on when the oldest active account on your credit report was opened and may influence your FICO score by up to 15%.

Keep in mind that closing your only credit card account might also adversely impact your FICO score by reducing the types of current credit accounts (credit mix).

7. Negative Items on Your Credit Report

Certain types of negative credit-related events could have a devastating impact on your credit score. Some of them will even stay on your credit report for up to ten years. The most common concerns include the following:

• Late Payments: Payments made 30, 60, and 90 days late are all reported to the credit bureaus. Even one 30-day late payment can drop your credit score significantly. 
• Accounts referred to collections: In most cases, once a balance has remained delinquent for more than 90 days, the original creditor will refer your account to a third-party collection agency.
• Eviction: When a consumer fails in maintaining their rent payments, such as for an apartment lease, the landlord or property management company will likely begin eviction proceedings through the local court that compels you to promptly vacate the property.
• Foreclosure: When a homeowner falls behind on their mortgage payments, the lender will likely begin the process of foreclosure. Here, the debtor must vacate the property, surrendering it back to the lender.
• Bankruptcy: A bankruptcy is a legal process for consumers that typically have become overwhelmed with debt and are now deemed as insolvent. In the short term, consumers entering the bankruptcy process will likely remain ineligible for any forms of financing for a while.

How long does it take to build credit after these types of derogatory marks appear on your credit report? When significant blemishes exist on your credit report, it will be a challenging process; however, various methods and strategies exist for rebuilding your credit.

Good starting points include obtaining a secured credit card, being added as an authorized user on someone’s credit card account, and obtaining a credit builder loan. Creating positive credit report entries can begin generating some results over several months.

8. You Opened A New Account

We previously discussed how applying for new credit accounts will generate a hard credit inquiry that usually has a somewhat minor negative effect on your credit profile.

Despite having a solid credit history, your credit score may decline once a new account is opened. However, over several months of making timely payments, the credit score will likely rebound and should exceed the earlier level.

The length of credit history factor that influences FICO scores also considers the average age of all credit accounts; therefore, the new account will likely have a slightly negative impact on your average.

If you get a new credit card, the new account may boost your credit score by increasing your total available credit, thus potentially improving your credit utilization ratio. 

Also, if the new account involves a new type of credit, it might improve your overall credit mix.

Effectively Managing Your Credit 

The calculations and formulas used in the models that ultimately generate your three-digit credit score can create confusion and frustration. Understanding the ways that the variables influence your score allows you to more proactively manage your credit profile.

In the long term, having a solid track record of making timely payments on all credit accounts yields positive results. Most of the consequences stemming from events such as credit inquiries or paying off an installment account balance have a less dramatic and temporary overall impact.

CreditStrong helps improve your credit and can positively impact the factors that determine 90% of your FICO score.

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