Why Did My Credit Score Drop? Common Reasons and How to Fix Them
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Paying off a debt and seeing your credit score drop can be frustrating, especially when you were told that paying off your debts was a good thing. So why are you being penalized for doing the right thing? Your credit score is a crucial number that affects your ability to get loans, credit cards, and even housing. It's essential to stay on top of it and know the factors that can cause it to dip unexpectedly.
Let’s explore common reasons behind a sudden drop in your credit score and discuss practical tips to help you fix these issues. By staying informed and proactive, you can maintain a healthy credit score and secure your financial future.
Key Takeaways
Late or missed payments can significantly impact your credit score.
High balances on credit cards can lower your score.
Frequent applications for new credit can negatively affect your score.
A lack of diverse credit types can impact your score.
Closing old accounts can reduce the average age of your credit history.
Common Reasons for a Credit Score Drop
You made a payment late or missed a payment
Late or missed payments are one of the most common reasons for a drop in your credit score. Now, it’s not just paying your debt a couple days late, although that will cause you to incur a late fee, your credit score drops when you are 30 days or more late or if you miss a payment entirely. These actions can have a significant negative impact because payment history is the most heavily weighted factor in calculating your score at 35%.
How to Fix It: Set up automatic payments or reminders to ensure you never miss a due date. If you have missed a payment, pay it as soon as possible and contact your creditor to see if they will remove the late payment from your report.
Your credit utilization is too high
Credit utilization refers to the amount of credit you're using compared to your total credit limit. It is expressed as a percentage and is another key factor in determining your credit score. Here’s an example, if you have a total credit limit of $10,000 and your current balance across all cards is $4,000, your credit utilization ratio is 40%.
Lenders view high credit utilization as a risk indicator. If you are using a large portion of your available credit, it may suggest that you are overextended and at a higher risk of defaulting on payments. This can result in a lower credit score, making it harder to obtain new credit or favorable loan terms.
How to Fix It: One of the most effective ways to improve your credit utilization ratio is to pay down your credit card balances. Aim to use no more than 30% of your available credit. Ideally, keeping it even lower can be more beneficial for your credit score. Paying off your balances in full each month can also help maintain a healthy score.
💡 Pro Tip: Another strategy to lower your credit utilization ratio is to increase your credit limits. You can request a credit limit increase from your credit card issuer. If your request is approved, your total available credit increases, which can help lower your utilization ratio. However, this strategy requires discipline; avoid the temptation to spend more simply because you have a higher credit limit.
You applied for new credit
When you apply for a new line of credit, such as a credit card, mortgage, or personal loan, the lender will perform a hard inquiry (also known as a hard pull) on your credit report. This process involves the lender checking your credit history to assess your creditworthiness. While one or two inquiries may not have a significant impact, multiple inquiries in a short period can lower your score.
Each hard inquiry can slightly reduce your credit score because it indicates that you are seeking additional credit. Lenders may interpret multiple inquiries within a short timeframe as a sign that you are experiencing financial difficulties or are at a higher risk of overextending yourself. This perceived risk can result in a lower credit score.
How to Fix It: Be selective about applying for new credit and try to space out applications when possible. If you need to apply for new credit, research your options and choose the one that best fits your needs to minimize the impact on your score. Many lenders offer pre-qualification processes that involve a soft inquiry rather than a hard inquiry. Pre-qualification can give you an idea of whether you are likely to be approved for credit without affecting your score. Use this tool to narrow down your options before formally applying.
You closed an old account
Closing old credit accounts can seem like a good way to simplify your finances, but it can have unintended consequences on your credit score. One key aspect of your credit score is the average age of your credit accounts, which reflects the length of your credit history. When you close an old account, it can reduce this average age and potentially lower your score.
The length of your credit history makes up 15% of your credit score. It includes factors such as the age of your oldest account, the age of your newest account, and the average age of all your accounts. Longer credit histories generally lead to higher credit scores because they provide more data for lenders to assess your creditworthiness. Closing an old account can impact the following:
Average Age of Accounts: When you close an old account, it reduces the average age of your credit history, which can lower your credit score.
Credit Utilization Ratio: Closing an account also reduces your total available credit. If you have balances on other accounts, this can increase your credit utilization ratio, negatively affecting your score.
How to Fix It: Instead of closing accounts, consider keeping them open and using them occasionally to maintain a longer credit history. If you have already closed an account, focus on building a positive payment history with your remaining accounts.
You have errors on your credit report
Mistakes on your credit report, such as incorrect account information or fraudulent activity, can also cause your score to drop. Errors on your credit report can occur for various reasons and can have significant impacts on your credit score, potentially leading to higher interest rates, loan denials, or other financial inconveniences. More than 34%, of Americans found at least one error on their credit report, according to a new Consumer Reports investigation.
How to Fix It: Regularly check your credit report for errors and dispute any inaccuracies. You can request a free credit report from each of the three major credit bureaus annually at annualcreditreport.com. Dispute any inaccuracies promptly to ensure your score reflects your true creditworthiness.
Final Thought
Maintaining a healthy credit score is crucial for achieving your financial goals and securing the best possible terms on loans and credit cards. By understanding the common reasons for a credit score drop and implementing practical strategies to fix these issues, you can stay on top of your credit health. Remember, staying informed and proactive is key to safeguarding your financial future.
FAQs
Why did my credit score drop after paying off a loan?
Paying off a loan can sometimes lead to a temporary dip in your credit score because it reduces your credit mix and the length of your credit history. However, the long-term benefits usually outweigh the short-term impact.
How often should I check my credit report?
It's recommended to check your credit report at least once a year. You can request a free report from each of the three major credit bureaus annually.
Can closing a credit card hurt my credit score?
Yes, closing a credit card can hurt your credit score by reducing your available credit and shortening your credit history. It's often better to keep the account open and use it occasionally.
How can I dispute an error on my credit report?
You can dispute errors on your credit report by contacting the credit bureau that issued the report. Provide documentation to support your claim and follow up until the error is corrected.
Does checking my own credit score affect it?
No, checking your own credit score is considered a soft inquiry and does not impact your credit score.
