Your credit score plays an important role in many aspects of your life. Whether you're applying for a loan, renting an apartment, or securing a new job, your credit score can have a huge impact on the opportunities available to you. This number, which is used by lenders and creditors to assess your creditworthiness, serves as a reflection of your financial responsibility.
So it's no wonder that seeing a drop in your credit score can make your heart do the same.
If you’ve recently noticed a dip in your credit score, fear not! We’re here to break down why credit scores fluctuate, discuss which drops can be good in the long run, and outline how you can increase your score if it isn’t where you want it to be.
Are all credit drops bad?
Credit score drops can occur for various reasons, and it's important to differentiate between negative drops resulting from financial missteps and drops that happen for valid reasons.
Negative credit drops
Negative credit drops occur when you engage in financial behaviors that raise concerns among lenders and creditors. This may include late payments, defaults, high credit utilization, or collection accounts. These negative events have a direct and detrimental impact on your credit score.
Neutral credit drops
In some cases, credit drops occur for reasons that are simply part of responsible financial management. For example, taking out a new mortgage or financing a car can temporarily lower your credit score due to the hard inquiries and new debt— but that doesn’t mean it’s a bad thing.
Let’s take a closer look at the different reasons why a credit score may drop.
What can lower your credit score?
Credit scores can drop for a few reasons. If you’ve noticed yours take a dip, one of these may be the reason why.
1. Late or missed payments
One of the most significant factors that can lower your credit score is late or missed payments.
Payment history contributes to a significant portion of your credit score, so it's essential to prioritize timely bill payments. Even a single missed payment can have a detrimental impact on your credit score.
To mitigate this risk, establish a system to ensure prompt payments. Set up automatic bill payments or use calendar reminders to stay on top of due dates. Consistently paying your bills on time will demonstrate responsible financial behavior and positively impact your credit score.
2. High credit utilization ratio
Credit utilization refers to the percentage of your available credit that you're currently using. A high credit utilization ratio can negatively affect your credit score. Lenders interpret high credit utilization as a potential sign of financial strain or risk.
To maintain a healthy credit utilization ratio, aim to keep your credit card balances below 30% of your credit limit. For example, if you have a credit card with a $10,000 limit, try to keep your balance below $3,000. Regularly monitor your credit card balances and make efforts to pay them down to lower your credit utilization and boost your credit score.
3. Collection accounts and defaults
Unpaid debts, collection accounts, and defaults can significantly damage your credit score. When debts are sent to collection agencies or legal action is taken due to non-payment, it leaves a lasting negative mark on your credit report.
If you find yourself with collection accounts or defaults, it's important to take steps to resolve them. Contact the creditor or collection agency to negotiate a payment plan or settlement. Once you've fulfilled your obligations, make sure to obtain documentation stating that the account has been settled or paid in full. Taking action and resolving these accounts will help improve your credit score over time.
4. Bankruptcy or foreclosure
Experiencing bankruptcy or foreclosure can have a severe impact on your credit score. These events can significantly lower your credit score and remain on your credit report for several years. However, it's important to note that credit scores can gradually recover after these events, especially with responsible financial management moving forward.
Rebuilding credit after bankruptcy or foreclosure requires a strategic approach. Start by establishing a budget and maintaining a record of timely payments for any remaining debts. Consider applying for a secured credit card or a credit builder loan to demonstrate responsible credit behavior. Over time, these positive actions can help rebuild your credit score.
5. Opening new lines of credit
While opening a new line of credit can be necessary and even beneficial in certain situations, it's important to be mindful of the potential impact on your credit score. When you apply for new credit, it triggers a hard inquiry on your credit report, which can temporarily lower your credit score.
If you're shopping for a loan or credit card, try to limit your applications to a short period. This allows credit scoring models to recognize that you're seeking the best terms for a single loan, rather than multiple loans. Additionally, only open new lines of credit when necessary, and be cautious about taking on excessive debt.
If you’re about to take out a mortgage, do not open a new line of credit. Not only does this affect your credit score, but it affects your debt-to-income ratio.
6. Inaccuracies on your credit report
Inaccurate information on your credit report can negatively impact your credit score. It's crucial to regularly review your credit report and report any errors or discrepancies to the credit bureaus. Common inaccuracies include accounts that don't belong to you, incorrect payment statuses, or outdated information. Disputing these inaccuracies and having them corrected can help improve your credit score.
7. Closing credit accounts
Closing credit accounts, especially those with a long history, can potentially lower your credit score. This is because closing accounts reduces your overall available credit and can negatively impact your credit utilization ratio. However, there may be valid reasons for closing an account, such as avoiding high fees or managing excessive debt.
If you need to close an account, consider closing newer accounts first while keeping older, established accounts open to maintain a positive credit history.
Accounts can also close if they’re inactive. For instance, if you don’t use your Discover card often enough, they might send you notice of impending closure. It’s important to keep as many of your credit card accounts open as possible, because it gives you a favorable credit utilization ratio. Putting a single recurring charge that is automatically paid off each month is a great way to keep a card open without having to keep it in your wallet.
How to improve your credit score
Improving your credit score is an ongoing process that requires discipline and responsible financial management. Here are some basic tips to keep in mind to help you increase your credit score:
- Paying down debt: Too much debt shows that you may be overextended. Focus on paying off debts with the highest interest rates first while making at least the minimum payments on other accounts. As you reduce your debt, your credit utilization ratio improves, positively impacting your credit score.
- Maintaining a good payment history: Consistently paying your bills on time is one of the most effective ways to improve your credit score.
- Monitoring credit reports: Regularly check your credit reports to identify any errors or discrepancies that could be negatively impacting your credit score.
- Diversifying credit accounts: Focus on maintaining a balanced mix of credit types (revolving and installment credit) and managing them effectively.
- Keeping credit utilization low: Aim to keep your credit card balances below 30% of your available credit limit. Ideally, you would pay off your credit card balances in full each month to keep your utilization ratio even lower.
By implementing these tips, you can gradually improve your credit score over time. It's important to be patient and consistent in your efforts. Remember that building good credit is a journey, and responsible financial management is the key to success.
Maintain Credit Health
Your credit score plays a vital role in your financial well-being. By understanding the factors that can lower your credit score, you are now better equipped to maintain a healthy credit profile and take control of your financial future!