If you’ve discovered that your credit score has dropped, you’re probably angry and upset. That’s understandable. Your score is a little 3-digit number that has a huge impact on your life. That little number determines our ability to obtain a card, loan, mortgage, or even rent a house, and a drop in your score can leave you facing higher interest rates on everything you owe.
Don’t panic! In most cases, you can repair the damage, but you need to pinpoint the problem first.
Your credit score (also known as your FICO score) is based on the information contained in your credit report (also known as your credit history). If yours has dropped, something in your report has changed. Those changes may be small and hard to spot, but they will be there.
That number that controls your financial life comes from a review of five main components of your report, each given a different percentage of importance:
Payment history – 35% Impact
Amounts Still Owed – 30% Impact
History Length – 15% Impact
Number of Credit Types – 10% Impact
New Accounts and Selected Account Inquires – 10%
After assessing all of this information, FICO places you on one of the many different lists, based on your results. These lists are called scorecards. FICO then compares you with the other people on your particular scorecard to come up with your score. So which one of the above factors is dragging you down?
Here are a few examples of incidents that may have caused a drop:
Inquiries from lending institutions can hurt your credit. This rule is in place because a large number of inquiries can indicate that you are desperately looking for new loans or cards, a bad sign. Not all inquiries will count against you. Requests that you didn’t ask for, such as those made by an employer or by an organization evaluating you for a pre-approval offer, are not considered. FICO also recognizes that it is normal for consumers to go rate-shopping before taking on a major obligation like a mortgage, car loan, or student loan and that a cluster of inquiries from mortgage lenders does not mean that you are looking for a dozen different mortgages! In these cases, FICO assigns a “shopping period,” usually 30 to 45 days, and treats all similar inquiries in this period as a single inquiry. The inquiries you need to be concerned with are those that you initiate as part of an application for new credit. If you want a new card, for example, do not apply for a dozen different cards to see who approves you, because that will give your score a punch in the gut. Review the criteria, choose one card that is appropriate for you, and apply for that. A single inquiry may knock you back five points, so it does matter!
Quick tip—Inquiries can knock you back, but it is a temporary drop that will bounce back. FICO only considers inquiries for about one year.
It might not sound like much, but having just one loan or card payment that was over 30 days late can have a serious negative impact. Payment history is the single most important factor in FICO’s calculations. If you were more than 30 days late on a payment, the overdue bill would have been reported to the reporting bureaus, causing a drop in your golden number once the incident popped up on your report.
Your credit utilization ratio might be over 30%. Say what now?
If you’re not familiar with the term, your utilization ratio is the percentage of your card limit that you are using. If your card’s limit is $5,000, and you have $2,500 sitting on your card’s balance, your utilization ratio is 50%. Pretty straightforward, right? What could have caused a problem? Well, if your utilization ratio is more than 30%, it’ll have a negative impact. Keeping the usage to 30% or less is best. Listen carefully; you might hear the sound of a few shopaholics falling out of their chairs as they read this news.
Quick tip—Maintain a utilization ratio of 10% and FICO (and potential creditors) will love you.
Did you make an expensive purchase with your card recently? Don’t worry; we can keep that Ming Dynasty tea-set you bought a secret. The catch is that purchase may have caused your credit to drop even if you paid the balance in full by the end of the month, because the card issuer may have reported the balance before your payment was received.
We’re still not done with utilization issues. You can probably see where this one is going, though. Your score could drop if the issuers of one or more of your cards have lowered your limit. Your balance may stay the same, but if your limit goes down, the utilization ratio goes up.
For example, you’ve got a card with a limit of $5,000, but you’re using a balance of only $1,250. Cool, a credit utilization ratio of 25%. All is well. If the limit on that card drops to $2,500, your utilization ratio suddenly shoots up to 50%, even with that same $1,250 balance.
Closing a credit card account has a good chance of hurting your score, especially if there is still a remaining balance on the card. The effect of closing an account is the same whether the closure came from you or from the folks who issued you the card. It doesn’t make a difference who shut it all down; a closed credit card account will ding you.
If you had an unpaid account sent to collections, your score probably fell faster than an elephant on a unicycle. There’s no sugarcoating this one. Any account sent to collections will show up on your report, and when it does, it’s going to hurt. If you’re the type of person who pays all your bills on time, you won’t make this mistake.
Quick tip–If you’re not the type of person who pays all bills on time, become the type of person who pays all bills on time. Paying bills on time is the single most important thing you can do for your financial history.
Not a lot of people know about this one, but if a collection account is dropped from your report, your score might change. Why? As mentioned above, FICO compares your profile to the profiles of others on your specific scorecard. Even with a collections account on your report, you may still have been at the top of your particular scorecard. When the negative information of a collections account finally drops off your report, you will most likely move to a different scorecard. Do you see where this is going? Though you might have been at the top of your previous scorecard, you could be at the bottom of the new one. This shift can tank your score.
Quick tip–A drop under these circumstances is only temporary. Just keep up with the positive actions on your report, and your score will improve quickly.
If you’ve ever faced bankruptcy, it’s good to know that this incident falls off your report after about ten years. If it does, guess who is relocating to a new scorecard? That would be you. That new scorecard is probably full of people who haven’t filed for bankruptcy, which will likely result in a drop. They know how to get you at every turn, don’t they?
Quick tip–Don’t fret, it will pass. Just keep all your accounts in the black, and your score will improve again.
Mistakes happen, and you should review your report regularly and very carefully. The people working at report agencies are still people, and people make mistakes. For example, your report may claim you missed a loan payment when you didn’t. An error like that can hurt you. Sometimes a card issuer increases your limit but does not report that promptly, which hurts your utilization. In some cases, an account belonging to someone who shares your name may be incorrectly assigned to you, or you may even be hit by identity theft, with some low-life borrowing in your name and destroying your credit. Any errors or issues of this kind must be disputed immediately online through the three major reporting companies; Equifax, Experian, or TransUnion.
Quick Tip—Check your report as soon as you get it, and if you find an error, get your skates on! You have only 30 days to file a dispute from the day you received your report.
Your score is of vital importance in our credit-based economy. Using the list above, you should be able to uncover what caused the drop. Once you’ve pinpointed the issue, make some serious efforts to resolve the issue, along with the necessary lifestyle changes to protect your score in the future. All it takes to fix most of these issues is a good-faith effort, and time.