You paid your bills on time. You satisfied old loans and paid-off credit cards. You did exactly what you’re supposed to do: eliminate debt. And you monitor your credit report like a hawk.
So why is it that your credit score took a hit? Shouldn’t it go up, not down?
There is a method to this madness, actually. And understanding how and why these fluctuations happen is instrumental to ultimately improving your credit worthiness.
Here are six clear-cut reasons why your credit score can dip.
1. Too Much Credit
Making sure you don’t run up too much debt is not enough. It’s important to spend an amount far lower than your credit limit. That is how you can decrease your interest payments and ultimately your debt. How much of your credit you use is known in the industry as “credit utilization.” Financial experts, including Tom Quinn of the data analytics company FICO, recommend that you should only be using 20 to 30 percent of your credit limit. That way you can minimize the negative impact on your credit rating.
You can calculate your own credit utilization by dividing the amount of debt you owe on your credit card statement by your credit limit. That means if you have a $5,000 balance and a $10,000 credit limit, that’s 0.5, or a credit utilization of 50%.
The revolving balance on your card can change every month, and so does your credit utilization. So if that number goes up and exceeds a level FICO sees as significant, your score could drop. Likewise it could increase if your credit utilization goes down to a level FICO has determined to be important.
The revolving balance on your card can change every month, and so does your credit utilization. So if that number goes up and exceeds a level FICO sees as significant, your score could drop.
And there’s no way to know what the number is from month to month. FICO looks at credit utilization both on an account-by-account basis and overall. Just remember, the lower the utilization, the better your credit score will be.
2. Yay! You Paid Off That Loan. Uh-oh…
Once again, this is a result of your credit utilization. Paying off loans is good. Not having that loan on your credit report to show you’re a good risk can be bad. It’s how the credit reporting agencies know you make payments on time. They like to see you have been doing so regularly. Not having the loan can hurt your score.
Paying off a loan is like the chef taking something off the menu in your favorite restaurant. There are fewer items to choose from. And when lenders analyze your credit worthiness, they don’t have your loan to show you’re a good risk.
But not paying off the loan would be far worse, so don’t default. Pay it off. Just understand the impact it will likely have on your score.
3. Oops! You Forgot Something
Yes, you’re human, everybody makes mistakes. But missing a payment will cost you. Your payment history is the most significant thing that impacts your credit score. Even one 30-day late payment can be significant. Payment histories account for 35 percent of your credit score.
That late payment stays on your credit file for up to seven years. So, do everything you can to avoid missing a payment. That’s how to avoid a long-term negative impact on your credit score. By the way, the amount of debt you carry accounts for 30 percent of your score, length of credit history is 15 percent, and it’s 10 percent each for new credit and the mix of credit cards you carry. These percentages may vary based on an individual’s credit profile.That late payment stays on your credit file for up to seven years. So, do everything you can to avoid missing a payment. That’s how to avoid a long-term negative impact on your credit score. Click To Tweet
4. Those Old Cards Still Have Value
Sure, it might seem the smart thing to do, but closing some of your older or neglected credit card accounts can be another reason your score can dip. Those old accounts are like childhood friends. They’ve kept in touch over the many decades and can be your greatest and longest source for understanding who you are. They tell everybody how you got to where you are now. Same with your credit history. If you close those old accounts, there’s less information for lenders to determine your creditworthiness and your score. And without it, your score takes a hit.
5. Too Many New Cards
So now that you’ve closed those old cards, you might as well sign up for a few new ones. Maybe a gas card. A travel miles reward card. Oh, there’s your favorite store with a credit card offer. And guess what: you’ve just put a bullet in your credit score by opening several credit accounts in a short period of time.
To lenders, that’s a red flag representing greater risk. This is especially true for consumers who have not yet established a long positive credit history. When a financial institution asks your permission to run your credit report to review your application for new credit, it’s called a “hard inquiry”. That stands in contrast to “soft inquiries”, which is when you check your own credit report, or your employer or insurance company checks your report, or any time a lender checks your credit without your knowledge or permission.
Remember: checking your own credit report and scores will never affect your FICO Credit Score, so do it often.
6. The Secrets of FICO
Unfortunately, there’s no way to look up this information online. FICO changes its formula periodically. That effort is made to improve the formula and make it a more accurate indicator of credit risk. FICO’s credit scoring competitors change their formulas, too. The result is that the fluctuations in the formula and how it is applied can result in changes to your score. Sometimes positive, sometimes not.
The bottom line: you need to maintain a little bit of debt, a manageable amount, to keep your score at its peak. Think of Goldilocks: not too little, not too much. Just the right amount. And your credit report will thank you for it.