A high credit score can help you get the best interest rates on car and home loans, and can make approval easier for a credit card with airline miles for rewards.
Monitoring your credit score and doing all you can to improve it, such as paying bills on time, can help you decide when the best time is to apply for new credit.
But what if your credit score takes a sudden nosedive?
What could cause such a drop? It may not be a surprise if you know your credit score and can’t pay your bills.
But there are other reasons why a credit score can suddenly drop. The good news is that credit scores change often, so you can work to improve them by solving what’s hopefully a short-term problem.
Here are some ways credit scores can drop a lot in a little amount of time:
Credit Card Payment Missed
Being 30 days late on a credit card can drop a very good or excellent credit score by 63 to 83 points, according to FICO. Someone with a fair credit score may only see a drop of 17 to 37 points.
The higher the credit score, the worse the impact will be.
Miss payment for 90 days and a fair credit score only drops 27 to 47 points. The excellent credit score could drop from 113 to 133 points.
Payment history is the most important factor in determining a credit score. It makes up 35% of a FICO score calculation and lowers a score immediately. Not paying credit accounts on time is a sign of risk that you won’t pay other creditors, and creditors don’t like risk.
Start making timely payments again and your credit score could improve quickly, depending on your credit history and payment behavior after missing previous due dates. Even better is to pay your credit card bills off in full each month.
New Credit Card Application
Applying for a new credit card results in card issuers pulling your credit report to see how much of a risk you pose. This is called a hard inquiry, or “hard pull,” and temporarily lowers your credit score a few points.
Hard inquiries stay on a credit report for two years, but FICO only considers ones from the last 12 months.
Either way, they can drop a credit score.
If you don’t apply for credit too often, then your score shouldn’t fall too much. In the long run a credit card can be used to build credit by charging purchases and paying them in full by the due date. Do that, and your score will increase steadily.
A way to get around hard pulls affecting your credit report is to use preapproval or prequalification offers from card issuers. Also spread out your credit applications over time, such as waiting at least three months between applying for new cards.
Charged A Large Purchase
Charging a large purchase such as new appliances or an auto repair bill to a credit card can also cause a score to drop, though it shouldn’t if you pay the bill in full when it arrives.
A large purchase can leave a high balance on your credit card, which results in a high credit utilization rate being reported to the credit bureaus.
Also called a debt-to-credit ratio, it’s a measure of how much credit you’re using compared to how much is available. Use more than 30% of your available credit and your score will likely drop. A high credit utilization rate is a sign of financial risk and that you’re relying on credit to stay afloat.
Before putting a big expense on credit, make sure you can pay it off before the billing cycle ends. Carrying a high balance will not only raise your credit utilization rate, but will cost you high interest charges.
A Loan Was Paid Off
Paying credit card debt off completely improves a credit score. Paying off installment debt such as a mortgage, car loan or student loan, however, can hurt it.
Credit mix makes up 10% of a FICO credit score, so having other types of credit such as a car or home loan adds to that mix and improves your credit score. But only if you’re making regular payments on those loans on time.
Creditors want to see that you can manage different types of debt.
This doesn’t mean you should extend a student loan so that you still have a mix of credit types. If you can afford to pay off any loans, you should. Don’t keep a loan that you’re paying interest on as a way to improve your credit mix.
Not having debt will help your overall financial life. And chances are that sooner or later you’ll need another loan, and you’ll be back to managing different types of debt again.
Credit Card Closed
Closing a credit card account that you haven’t used in years is enticing, but it could lower your credit score.
The length of your credit history makes up 15% of your FICO score. The longer you have active credit cards, the longer your credit history will be.
Closing an old credit card will also lower your available credit limit. That gives you less credit to utilize, so your credit utilization rate could go up.
However, there’s no point in keeping a credit card with an annual fee if you no longer use the card. Ask the issuer to drop the fee or switch you to a card with no annual fee. If it won’t, then a drop in a credit score is worth no longer having to pay an annual fee on a card you don’t use anymore.
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