Few things in personal finance are scarier — or more bewildering — than opening your credit report and seeing that your credit score suddenly has dropped.
Your credit score – that little number – plays a large role in your financial life. 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 could also influence what interest rate you potentially pay..
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 are a prediction of whether or not you’re going to pay your bills over the next couple of years. 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.
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. 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 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 suggests you have a firm handle on your finances and are unlikely to fall into delinquency. That perception pushes your score higher.
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 150-200 points or more in the wake of a bankruptcy. In most cases, however, you can, and will be able to re-establish credit within one to two years.
Sometimes, however, your score can drop for unexpected or even counterintuitive reasons.
For example, 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.
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,
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.
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. 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.
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, including:
– Resume on time payments
— 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.
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.