Are you frustrated because your credit score dropped suddenly for no apparent reason? Laura answers a listener question and covers 5 lesser-known reasons why credit scores can drop unexpectedly. These tips will help you raise your credit score as quickly as possible.
Lauren H. says “I subscribed to your podcast after a friend recommended it a few months ago and have really enjoyed it. I find myself more frequently discussing money issues with my friends and these honest conversations really help all of us to get a better handle on our finances.
Here’s my question: Each month I receive my FICO credit score on one of my credit card statements and last month my credit score dropped 16 points. I checked my Experian credit report and didn’t find anything wrong. I don’t have any late payments, closed cards, or new accounts. What might be the reason for this drop?"
Lauren, thanks for your question and being a new show listener. I know how frustrating and shocking it can be when your credit score drops suddenly for no obvious reason.
In this post we’ll cover 5 lesser-known reasons why credit scores can drop unexpectedly. I’ll give tips to raise your credit score as quickly as possible so the drop doesn't hurt your finances.
See also: The Credit Score Survival Kit (a free video tutorial to build credit fast!)
How Credit Scores Work
Credit scores can seem mysterious because they’re created using many factors in your credit report. There are hundreds of different credit scoring models used by companies such as mortgage lenders, vehicle lenders, insurers, and merchants.
Each scoring model uses a complicated algorithm to evaluate your credit history. They all use slightly different factors and scoring ranges--some even use letters instead of numbers.
Additionally, there are 3 nationwide credit bureaus (Experian, Equifax, and TransUnion) that may not have the same information about you since creditors may only report data to one or two of them. So your credit score depends on which credit report is used in conjunction with which scoring model.
FICO is one of the most popular scoring model and uses a score range from 300 to 850. The higher your number the less risky you appear to potential lenders and merchants.
FICO is very transparent about the factors and weights they use to calculate your credit score:
- Payment history: 35%
- Amounts owed: 30%
- Age or length of credit history: 15%
- New credit inquiries: 10%
- Mix of credit types: 10%
Since Lauren doesn’t have any late payments or changes with her accounts and still had a 16-point credit score drop, what gives? Well, some changes to your scores may not be easy to spot because they’re happening behind the scenes due to not-so-obvious reasons.
Related: 5 FAQs About Your Credit Score
5 Lesser-Known Reasons Why Your Credit Score Dropped
Here are reasons why your FICO or another brand of credit score could drop, making you appear riskier to potential lenders and merchants.
Reason #1: You made an expensive credit card purchase
Lauren didn’t mention her recent spending patterns, but making a larger than normal credit card charge is one of the most common reasons for an unexpected credit score drop.
As I mentioned, the amount you owe makes up about one-third of your score. And the driving force behind it is something called credit utilization. Your credit utilization ratio is a simple formula compares the amount you owe to your available credit limit on revolving accounts, such as a credit card or a line of credit.
For example, if you have a credit card with a $1,000 credit limit and just bought a TV that brings your total balance up to $900, you have a 90% credit utilization ratio. In general, the lower your ratio, the better for your credit scores. Maintaining a utilization below 20% will give you the biggest benefits for your credit.
But wait a minute. What if you pay off that $900 balance by your credit card’s statement due date? Many people mistakenly believe that they can max out a credit card as long as they pay it off on time.
Here’s why that doesn’t work. Your credit card company could report your balance to the credit bureaus before your payment was received. In other words, paying off your entire credit card balance every month generally does not improve your utilization ratio.