If you’re working to rebuild your credit score to get a good rate on an auto loan, or even to prepare for home ownership, chances are you’re monitoring it pretty closely, and you’re hoping it continues to increase.
But this isn’t always the case. Your credit score can drop for a number of reasons, even if you don’t miss a payment, or do anything wrong. Here are the 5 most common reasons for a sudden credit score drop.
1. You Inquired For A New Line Of Credit
Every time you try to open a new line of credit – whether it’s a credit card, a personal loan, a car loan, or any other type of credit line – the issuing institution will conduct a credit check or “hard inquiry”.
Hard inquiries make up about 10% of your FICO credit score. If you have a large number of inquiries for credit in a short period of time, this is a sign of risky behavior – and it can lead to a drop in your credit score. Try to limit the number of inquiries you have, to keep your credit score high.
2. You Opened A New Credit Account – Decreasing The Average Age Of Your Credit
If you open one or two new credit accounts, this can actually harm your credit score. Age of credit is another important factor when calculating your FICO score, and it makes up 15% of your score.
Here’s an example. You have a 4 year-old auto loan, and one credit card that you’ve had for 5 years. The average age of your credit accounts is 4.5 years, which is great!
Then, you apply for two rewards credit cards, and are accepted. Because these accounts are brand-new (0 months), the average age of your credit is about 2 years, 3 months – which is not as good. This could cause a drop in your credit score.
3. You Closed An Old Credit Card Old Account
Closing old credit card accounts may seem like a good idea, but it most cases, it’s not. When you close an old credit card account, it may be removed from your credit history, which can negatively impact the average age of your credit lines.
It may also increase your debt utilization, which is measured by comparing your total revolving debt balance to your maximum credit limit. Both of these things can cause a drop in your score.
In general, you should keep your old credit cards open and active, as long as they do not have a monthly fee. Simply pay a cheap bill with one of them every month. They’ll help you continue to build your credit score.
4. You Paid Off A Loan
Counter-intuitively, paying off a loan can actually hurt your credit, at least for a month or two. “Credit mix” is another big factor in your FICO score.
It’s best to have a combination of revolving credit, like credit cards, as well as installment credit, like mortgages, auto loans, and personal/student loans.
If you finish paying off a loan, your credit mix may change, which could cause a drop in your credit score.
5. You Made A Large Credit Card Purchase And Haven’t Paid It Off
Your total outstanding debt makes up about 30% of your FICO score. The more debt you have, the lower your score will be, generally speaking. This is measured by your “debt utilization ratio”, which we mentioned in part 3.
Ideally, you want to keep your debt utilization at around 30% or lower. For example, if you have $10,000 in credit available over 3 cards, and you make a $5,000 purchase and don’t pay it off right away, your credit utilization will be 50% or higher – which can cause your score to drop.
As a rule, do your best to pay down your credit card debt every month, and keep your debt utilization at 30% or lower to avoid drops in your credit score.
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