Few things in personal finance are scarier — or more bewildering — than opening your credit report and seeing that your credit score suddenly has dropped.
That little number plays a large role in your financial life, says John Danaher, president of consumer interactive at TransUnion, one of the nation’s big three credit reporting agencies. A poor credit score can damage prospects for getting the credit card you want, or the terms you need on a mortgage or auto loan. “It will influence what interest rate you potentially pay,” Danaher says.
Many factors can cause your credit score to slip, or even to free fall. Knowing which financial actions lower your score can help you avoid such mistakes.
Top Two Reasons Your Credit Score Might Slip
Credit scores come in many different varieties. The FICO score is the best known: Its creator estimates that 90 percent of top lenders use it. Several years ago, the three major credit reporting agencies — Equifax, Experian and TransUnion — created VantageScore, another credit scoring model. Ultimately, lenders use all types of credit scores for the same purpose, Danaher says.
“Credit scores are simply a prediction of whether or not you’re going to pay your bills over the next couple of years,” he says.
Certain financial behaviors that drive your score down indicate you are at greater risk of not paying your bills on time and in full. Failing to make monthly payments is the most common reason people see their credit score decline, Danaher says.
When you miss a payment, it triggers the ultimate warning to lenders that you have a history of delinquency and are at high risk of not meeting your obligations in the future. “If you’ve demonstrated that behavior, obviously that has a serious impact on your score,” Danaher says.
[Read: The Best No-Annual-Fee Credit Cards of 2018.]
If you have a high FICO score, you could see it tumble by about 100 points simply for having a single payment 30 days past due, according to Equifax.
Lenders also look closely at your credit utilization ratio, which measures how much of your credit you use in relation to your total available credit. If you are using a lot of your available credit — such as running up large credit card bills each month — it indicates that you might be stretching to cover monthly expenses. That can have a negative impact on your score, too.
By contrast, a low credit utilization ratio of no higher than 30 percent, Danaher says, suggests you have a firm handle on your finances and are unlikely to fall into delinquency. That perception pushes your score higher. “This is why your score tends to fluctuate — because your balances tend to fluctuate,” Danaher says.
Can Arkali, principal scientist at FICO, agrees that payment history and the amount of debt you carry play the biggest role in determining your credit score. “Those two categories combined typically make up 60 to 65 percent of your score,” he says.
Other Factors That Can Lower Your Credit Score
A host of other factors also can impact your score. These include:
Opening new lines of credit. Every time you apply for a new credit card, the lender is likely to check your credit history. Such an inquiry appears on your credit report and can cause your credit score to drop modestly for a period. Apply for several new accounts in a short time, and your score will fall even further.
Having an account sent to collections. It is bad enough to miss payments. But if you become so delinquent that your account ends up with a collections agency, your credit score is likely to take a big hit.
Filing for bankruptcy or losing a home to foreclosure. Few things damage a credit score as much as these two events. For example, a strong FICO score can easily plummet by 200 points or more in the wake of a bankruptcy. In most cases, it will take years for your score to recover.
Other events that can cause your score to fall include selling your home as part of a short sale, and being subject to tax liens, repossessions and judgments.
Sometimes, however, your score can drop for unexpected or even counterintuitive reasons.
For example, Danaher says some consumers close one or more credit card accounts so they are less tempted to ring up excessive levels of debt. This seemingly responsible action can drop their scores instead of raising them. That is because the length of your credit history impacts your score. Closing a 15-year-old credit card account shortens that history, particularly if it is the oldest of your credit accounts.
[Read: The Best Starter Cards for Building Your Credit.]
“Maybe you want to look at the impact of closing that older account, even though you might not be using it,” Danaher says. “Because it could negatively affect your score.”
Arkali agrees that closing credit accounts poses hidden dangers. “We never ever recommend an individual start closing their unused accounts in the hopes of increasing their FICO score,” he says.
Mistakes’ Effect on Your Credit Score
When you miss a payment, close a credit card account or engage in any other potentially damaging financial behavior, lenders are likely to report such information to credit reporting agencies within one to two months, Arkali says.
“At that point in time, if a score is recalculated for that given individual, then the score would certainly incorporate that information,” Arkali says.
Negative information can remain on your credit report — and impact your credit score — for up to seven years, according to Equifax. The nature of your action will largely determine how severely your score drops. In some cases, the damage is minor. For example, Danaher says he routinely runs up big credit card bills over the holidays. When he checks his score a month or two later, he sees that it has dropped.
“It tends to be, I don’t know, 20 or even 30 points lower than usual because I’m using more than 30 percent of my available credit,” he says.
Your existing FICO score also has an influence on how much a negative credit event will impact your score. If you have a relatively low FICO score, you might not see a significant drop following a slip-up, Arkali says. That is because it is likely you already have some existing negative information on your credit files. So, your scores have less room to fall.
“But when it comes to a consumer who has been squeaky clean for years and years — who would be starting with a really, really high FICO score — then that individual can actually see a more significant drop in their FICO score,” Arkali says.
How to Fix a Falling Credit Score
If your score dips, take steps to get it back on track. Start the process by finding out why your score tumbled. Your credit report should include reason codes that explain what type of event negatively impacted your credit score. Once you know that information, do what is necessary to turn your score around, Arkali says.
“Demonstrate an ability to manage credit as responsibly as possible,” he says.
[Read: Best Credit Cards for Bad Credit of 2018.]
For example, make payments on time consistently. The more recent a missed payment is, the more it will impact your FICO score. With time, your score should start to rise if you continue to make payments on schedule, Arakali says.
Other things you can do to raise your score include:
— Pay down debts and keep credit card balances low.
— Open new lines of credit and use them responsibly. While opening a new account might nick your credit score in the short term, responsible use should cause the score to rise over time.
— Look for errors on your credit report and ask the credit reporting agencies to correct them.
Arkali compares the process of turning around your score to starting an exercise regimen with the goal of getting more physically fit. “It’s not going to happen overnight,” he says. “It’s going to take time, and it’s going to take discipline.”
If the negative mark is minor, you might not have to wait too long. Danaher says he quickly pays off his debts after his annual holiday spending sprees. Once he does so, his score soon recovers. “That January score is typically the lowest of the year for me,” he says. “But by February or March, it’s back up to where it was because I pay my credit card balance.”
However, missed payments and other more serious mistakes cause longer-term damage to credit scores. If you find yourself in this boat, you will need to be more patient. In the meantime, get things moving in the right direction.
“The most important thing is to stop the bleeding and make sure that you don’t miss any further payments, because the clock basically starts over again,” Danaher says.
Danaher acknowledges that advice for establishing and maintaining a solid credit score can get complicated. “So, I try to keep it as simple as possible: Pay your bills on time, use about 30 percent of your available credit and be careful about closing old accounts,” he says. “If you do those three things, you’ll be fine.”
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Here’s Why Your Credit Score Might Fall originally appeared on usnews.com
